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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 DECEMBER 31, 2000
                                       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 NUMBER 0-21126

                             SONICBLUE INCORPORATED
                           (FORMERLY S3 INCORPORATED)
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S>                                                           <C>
                          DELAWARE                                         77-0204341
      (STATE OR OTHER JURISDICTION OF INCORPORATION OR
                        ORGANIZATION)                         (I.R.S. EMPLOYER IDENTIFICATION NO.)
               2841 MISSION COLLEGE BOULEVARD
                  SANTA CLARA, CALIFORNIA                                    95054
          (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                         (ZIP CODE)
</TABLE>

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 588-8000
        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                        COMMON STOCK, $0.0001 PAR VALUE
             SERIES A PARTICIPATING PREFERRED STOCK PURCHASE RIGHTS

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

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

     The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $291,975,848 as of February 28, 2001, based upon
the closing price on the Nasdaq National Market reported for such date. This
calculation does not reflect a determination that certain persons are affiliates
of the Registrant for any other purpose.

     93,485,127 shares of the Registrant's Common Stock, $0.0001 par value, were
outstanding at February 28, 2001.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Items 10 (as to directors and Section 16(a) Beneficial Ownership Reporting
Compliance), 11 and 12 of Part III incorporate by reference information from the
Registrant's Proxy Statement to be filed with the Securities and Exchange
Commission in connection with the solicitation of proxies for the Registrant's
2001 Annual Meeting of Stockholders to be held on May 23, 2001.
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                             SONICBLUE INCORPORATED

                                   FORM 10-K

                                     INDEX

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                                   PART I

Item 1.   Business....................................................    1
Item 2.   Properties..................................................    9
Item 3.   Legal Proceedings...........................................   10
Item 4.   Submission of Matters to a Vote of Security Holders.........   11

                                  PART II
Item 5.   Market for Registrant's Common Equity and Related
          Stockholder Matters.........................................   12
Item 6.   Selected Consolidated Financial Data........................   13
Item 7.   Management's Discussion and Analysis of Financial Condition
          and Results of Operations...................................   13
Item 7A.  Quantitative and Qualitative Disclosures About Market
          Risk........................................................   38
Item 8.   Financial Statements and Supplementary Data.................   40
Item 9.   Changes in and Disagreements with Accountants on Accounting
          and Financial Disclosure....................................   68

                                  PART III
Item 10.  Directors and Executive Officers of the Registrant..........   68
Item 11.  Executive Compensation......................................   69
Item 12.  Security Ownership of Certain Beneficial Owners and
          Management..................................................   69
Item 13.  Certain Relationships and Related Transactions..............   69

                                  PART IV
Item 14.  Exhibits, Financial Statement Schedules and Reports on Form
          8-K.........................................................   69
SIGNATURES............................................................   73
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                                     PART I

ITEM 1. BUSINESS.

     When used in this Report, the words "expects," "anticipates," "estimates,"
"believes," "plans," and similar expressions are intended to identify
forward-looking statements. These are statements that relate to future periods
and include statements as to the Company's expected net losses, expected
expenditure levels and rate of growth of expenditures, expected cash flows,
trends in gross margin, sources of revenues, product mix, trends in average
selling prices and product life cycles, the adequacy of capital resources,
growth in operations, expectations regarding research and development efforts
and related expenses, the sources and availability of components and
manufacturing capacity, our expectations regarding customer and distributor
relationships, our efforts to expand sales and distribution channels both
domestically and internationally, anticipated market growth, our ability and
intent to develop, manufacture and market future and enhanced products,
including firmware and software, our ability commercialize products under
development, the features, benefits, performance, upgradeability and utility of
our current and future products, our ability to expand our position as a leader
in multimedia and connectivity products, the strategy for our refocused business
and the expected timing and completion of restructuring plans, our objectives of
capitalizing on new technologies, expanding international sales, increasing
market penetration for our products and expanding our digital media products to
include video and personal television, our efforts to develop strategic
relationships, our ability to complete business transactions, including proposed
acquisitions and the proposed sale of our professional graphics division, our
ability to realize gains on our investments, the timing and impact of current
and future litigation, our strategy with regard to protecting our proprietary
technology and our ability to compete and respond to rapid technological change.
Forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those projected. These risks and
uncertainties include, but are not limited to, those risks discussed below, as
well as risks relating to development of new and enhanced products and their use
by our potential customers, unpredictability of market demand and general market
fluctuations, costs of components and potential component shortages or quality
deficiencies, our ability to obtain and retain customers, distributors,
component suppliers and manufacturing capacity, manufacturing difficulties or
product defects, our ability to develop and timely introduce products that
address market demands, our ability to refocus our business and execute our
business plan for our refocused business, our ability to enter into and work
with strategic partners and OEMs to accomplish the goals of those relationships,
the cost of accessing or acquiring technologies or intellectual property, the
impact of alternative technological advances and competition, the costs of and
our ability to integrate acquired businesses and in a timely manner, whether our
proposed acquisitions will be consummated, our ability to consummate the sale
our professional graphics division to ATI Technologies, potential payments of
specified liquidated damages, upon the occurrence of certain events described in
the investment agreement with VIA Technologies, developments in and expenses
related to litigation; and the risks set forth below under Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Factors That May Affect Results." These forward-looking statements
speak only as of the date hereof. The Company expressly disclaims any obligation
or undertaking to release publicly any updates or revisions to any forward-
looking statements contained herein to reflect any change in the Company's
expectations with regard thereto or any change in events, conditions or
circumstances on which any such statement is based.

     All references to "SONICblue," "we," "us," "our" or the "Company" mean
SONICblue Incorporated and its subsidiaries, except where it is made clear that
the term means only the parent company.

     SONICblue, Diamond, frontpath, HomeFree, Rio Volt, SupraExpress, Diamond
Mako, SupraMax and ProGear are trademarks of SONICblue Incorporated. Rio is a
registered trademark of RioPort, Inc. and is used by SONICblue under licenses
from RioPort, Inc. Other trademarks referenced herein are the property of their
respective owners.

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GENERAL

     SONICblue Incorporated designs, develops and markets products for the
digital media, consumer electronics, Internet appliance and home networking
markets. SONICblue's business is now focused on three principal business units,
Rio, frontpath and Access.

     Rio. The Rio division designs, develops and markets digital audio players.
Having introduced the industry's first portable MP3 player in 1998, Rio has
continued to launch additional portable players with enhanced features and
increased memory capacity for longer playback times. Rio has recently expanded
its digital audio offerings to include a removable in-dash player and a receiver
that uses existing phone lines to stream digital music from a home computer to
any room in which the receiver is located.

     frontpath. Through its wholly owned subsidiary frontpath, inc., SONICblue
pursues opportunities in the information appliance home and vertical markets
such as medical, education, travel and entertainment. frontpath is introducing
portable solutions to bring the power of the Internet to businesses by offering
a broadband, wireless information appliance focused on customized applications
and personalized information for anywhere, anytime use.

     Access. The Access business unit develops products under the Diamond brand,
including the Diamond Mako personal digital assistant, or PDA, HomeFree
networking products and Supra fax/modems. Access is focused on delivering
products that allow consumers to tie Internet appliances, or iAppliances, and PC
peripherals together and to enable multiple device or user access to a
high-speed Internet connection or a virtual private network.

     Pursuant to an Asset Purchase Agreement dated as of March 30, 2001,
SONICblue agreed to sell its professional graphics division to ATI Technologies
Inc. for $2.7 million in cash and further financial consideration of up to $7.3
million. Based in Starnberg, Germany, the professional graphics division
designs, develops and markets graphics solutions for Windows NT and Linux
workstations using IBM's high-end graphics technology.

     SONICblue sells its products through distributors, retailers, e-commerce
websites, including its own on-line e-store, mail order catalogs and national
reseller organizations. Headquartered in Santa Clara, California, SONICblue has
sales, marketing, customer care and technical facilities in several locations
including Albany, Oregon; Austin, Texas; Billerica, Massachusetts; Vancouver,
Washington; Hong Kong, P.R.C.; Paris, France; Saarbrucken, Germany; Seoul,
Korea; Singapore; Starnberg, Germany; Sydney, Australia; Taiwan, R.O.C.; Tokyo,
Japan; and Winnersh, U.K.

     SONICblue was incorporated as S3 Incorporated on January 9, 1989 in the
State of Delaware and changed its name to SONICblue Incorporated in November
2000. SONICblue operates in one principal industry segment.

BACKGROUND

     Prior to the transfer in January 2001 of its graphics chips business to S3
Graphics Co., Ltd., a joint venture between VIA Technologies, Inc., or VIA, and
a wholly owned subsidiary of SONICblue, SONICblue was a leading supplier of
graphics and multimedia accelerator subsystems for personal computers, or PCs,
for more than ten years. In September 1999, SONICblue made a significant
strategic shift by merging with Diamond Multimedia Systems, Inc., an established
PC original equipment manufacturer, or OEM, and retail provider of
communications and home networking solutions, PC graphics and audio add-in
boards, digital audio players and information appliances. Diamond products
included the Rio line of digital audio players, the Stealth and Viper series of
video accelerators, the Monster series of gaming accelerators, the Fire series
of NT workstation 3-D graphics accelerators, the Supra series of modems and the
HomeFree line of home networking products. The merger with Diamond established
SONICblue as a single graphics solutions provider, including the silicon, board
and software elements, in the retail, commercial and OEM PC graphics markets.

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     In November 1999, SONICblue and VIA established a joint venture to design,
produce and market high-performance integrated graphics and core logic chip sets
to the volume OEM desktop and notebook PC markets. The joint venture, S3-VIA
Inc., was jointly funded with access to both SONICblue's and VIA's technology as
well as distribution rights for developed products between SONICblue and VIA. At
December 31, 2000, SONICblue owned 50.1% of the voting common stock of S3-VIA
and, accordingly, consolidated the accounts of S3-VIA Inc. in its consolidated
financial statements. In January 2001, SONICblue's interest in S3-VIA was
transferred, along with SONICblue's graphics chip business, to S3 Graphics Co.,
Ltd., another joint venture between VIA and a wholly owned subsidiary of
SONICblue, as described in "Recent Developments" below.

     In January 2000, SONICblue publicly announced that it was exploring
business transactions intended to increase stockholder value by separating its
graphics chips division from its other business. In February 2000, SONICblue
purchased substantially all of the assets of Number Nine Visual Technology
Corporation, a supplier of graphics accelerator subsystems for PCs using
SONICblue graphics chips. The acquisition of the assets of Number Nine, a
supplier to IBM, allowed SONICblue to consolidate its graphics business with IBM
into a single source distribution model and furthered SONICblue's strategy of
becoming a single graphics solution provider to the PC graphics market. The
acquisition also added skilled hardware and software engineering resources to
SONICblue's existing teams.

     In August 2000, SONICblue announced the shut-down of its Diamond video and
gaming accelerator business. In September 2000, SONICblue formed frontpath as a
wholly owned subsidiary to develop information appliances, such as accessible
wireless portable devices to allow businesses and consumers to live connected at
home, at work and at play.

RECENT DEVELOPMENTS

     In November 2000, SONICblue acquired U.K. digital audio equipment
manufacturer Empeg Limited, known as empeg, for $1.9 million. One of the first
companies to design and bring to market digital audio players for automobiles,
empeg has become a part of SONICblue's Rio division, and empeg's technology
formed the basis for the recently introduced Rio Car audio player.

     In January 2001, SONICblue completed the transfer of its graphics chips
assets to S3 Graphics Co., Ltd., another joint venture between VIA and a wholly
owned subsidiary of SONICblue. The joint venture will manufacture and distribute
graphics products and conduct related research and development activities.
Pursuant to the joint venture agreement with VIA, SONICblue received 13 million
shares of SONICblue common stock as payment, and the joint venture assumed
certain liabilities relating to the graphics chips business. Upon the occurrence
of events specified in the investment agreement between SONICblue and VIA,
SONICblue must pay specified liquidated damages, subject to a maximum damages
cap. Under the joint venture agreement, SONICblue will also receive earn-out
payments if the new venture meets specified profitability goals. At closing,
SONICblue issued to a wholly owned subsidiary of VIA a warrant to purchase up to
2 million shares of SONICblue common stock at an exercise price of $10.00 per
share, for an aggregate exercise price of $20 million.

     In February 2001, SONICblue announced that it signed a definitive agreement
to acquire Sensory Science Corporation, whose assets include the Go Video,
California Audio Labs and Rave brands as well as an exclusive distribution
agreement with Loewe Opta GmbH of Germany. Pending the consummation of the
acquisition of Sensory Science Corporation, SONICblue has made a loan to Sensory
Science in the amount of $3 million and has obtained a warrant to purchase
5,357,143 shares of Sensory Science common stock.

     In March 2001, SONICblue signed a definitive agreement to acquire ReplayTV,
Inc., a developer of personal television technology. Under the terms of the
agreement, SONICblue will issue an aggregate of 15.5 million shares of common
stock and options and warrants to purchase shares of SONICblue common stock in
exchange for all of ReplayTV's outstanding equity, and ReplayTV will become a
wholly owned subsidiary of SONICblue. The agreement also provides that if the
value of the SONICblue common stock to be issued to stockholders of ReplayTV at
the closing of the transaction is less than $80 million, ReplayTV may terminate
the agreement unless SONICblue, at its option, either pays additional cash or
issues additional

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shares to bring the value at closing to $80 million. In connection with the
proposed acquisition of ReplayTV, SONICblue has made loans to Replay in the
amount of $10 million and agreed to loan ReplayTV up to an additional $6
million.

     In March 2001, SONICblue announced the proposed sale to ATI Technologies of
its professional graphics division, based in Starnberg, Germany, which produces
the Fire GL line of graphics accelerators. Under the terms of an Asset Purchase
Agreement, SONICblue will receive $2.7 million in cash and is eligible to
receive further financial consideration of up to $7.3 million, contingent upon
the Fire GL graphics business achieving future performance targets.

PRODUCTS

     Rio Digital Audio Players. The Rio 300 and Rio 500 were SONICblue's first
portable digital audio players, followed by the Rio 600, Rio 800 and Rio 800
Extreme. Rio players allow users to enjoy near-compact disc, or CD, quality
audio that has been uploaded to the device from a PC's hard drive in the MP3
compression format or Windows Media, or WMA, format. Users may download music
from the Internet and transfer music from personal CDs and other digital formats
for upload to, and playback using, a Rio player. The handheld Rio player uses
flash memory and is battery powered.

     Diamond shipped the industry's first hand-held digital audio player in
November 1998. In 1999, as competitors entered the market with similar first
generation devices, Diamond introduced the second-generation Rio 500 handheld
player. The PC and Macintosh-compatible Rio 500 stores and plays up to two hours
of music with improved fidelity and gives users more freedom to manage their
audio content, compared to the Rio 300, and uses a universal serial bus, or USB,
connection for faster upload speeds. Models developed after the Rio 300 are also
upgradeable to support future audio formats. In 2000, SONICblue introduced the
Rio 600 and Rio 800, with up to one and two hours of music storage,
respectively. For the fitness enthusiast, the Rio division partnered with Nike
to deliver the psa[play 60 and psa[play 120, both built for exercise and high
endurance activities. The recently released Rio 800 Extreme plays up to 12 hours
of music based on its 384 megabytes, or MB, of memory, consisting of 256MB
on-board memory with a 128MB backpack, a clip on or external memory device.

     The Rio division has also introduced two models of clip-on Rio memory
backpacks which offer an extra hour or two hours of storage for owners of Rio
600 and Rio 800 players. SONICblue currently expects to introduce additional
backpacks in the second half of 2001.

     In January 2001, SONICblue began shipping the Rio Volt, a portable CD
player that plays standard music CDs and recordable CDs containing MP3 and WMA
files.

     In addition to its handheld Rio devices, SONICblue has also been developing
other digital audio products for use in consumers' homes, offices and
automobiles. SONICblue recently introduced the Rio Car, a removable in-dash
digital audio player with models ranging from 10 gigabytes, or GB, to 60GB, or
up to 1,000 hours of music, based on technology from empeg, and the Rio Digital
Audio Receiver, a device that uses existing phone lines to stream digital music
from a home computer to any room in which a receiver is located. The Rio
division is developing new products that will give users other ways to enjoy
digital audio, including a Rio boombox featuring Boston Acoustics audio.

     Diamond Mako. SONICblue announced the launch of the Diamond Mako connected
organizer in October 2000, the first product to be released under an agreement
with Psion Computers PLC. The Mako is a PDA focused on mobile productivity,
combining organizer, spreadsheet, word-processing, e-mail and web-browsing
applications in a clamshell design that fits in a user's pocket. It includes a
full keyboard, 480-by-160 pixel display and 16MB of memory. Mobile connectivity
is available through an optional 56 kilobits per second, or 56K, travel modem or
through a compatible data and infrared modem phone linked to a network service
provider. The Diamond Mako synchronizes with PCs via its serial port docking
station, and users can connect to other PDAs via the standard infrared port to
beam contact data back and forth.

     HomeFree Home Networking and Digital Subscriber Line, or DSL, Residential
Gateway Products. SONICblue's Diamond brand HomeFree communications products
allow users to network multiple PCs

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throughout their home via phone or power lines to share Internet access, content
and peripheral devices and to engage in multiple platform applications such as
head-to-head gaming.

     SONICblue's HomeFree Phoneline USB uses a USB connection and is currently
the only cross-platform (Windows and Mac-compatible) home networking product on
the market. SONICblue's HomeFree Phoneline 10 million bits per seconds, or Mbps,
networking product allows users to share Internet access, content and peripheral
devices, transferring information at speeds of up to 10Mbps. In addition, the
recently announced HomeFree Asymmetric Digital Subscriber Line, or ADSL,
Residential Gateway allows users to network their DSL Internet connection
throughout their entire household. In January 2001, SONICblue announced the
HomeFree Powerline, a home networking solution based on Intellon Corp.'s
PowerPacket powerline technology, which allows multiple PCs to share broadband
Internet connections, MP3 music, video and peripherals, such as printers and
scanners, as well as play multiplayer games by plugging into a common power
outlet, transferring information at speeds of up to 10Mbps.

     In December 1999, SONICblue and Covad Communications, Inc., a nationwide
DSL service provider, agreed to jointly market and sell SONICblue's HomeFree
Phoneline and Residential Gateway products with Covad's services, providing
consumers with a one-stop shopping DSL solution.

     Supra Modems. Under the Diamond brand, SONICblue markets a family of
dial-up fax/data modems that include the SupraExpress and SupraMax family of
modems. The SupraExpress family of modems are external fax/data modems that
connect via a serial cable or USB interface, support the 56K International
Telecommunications Union, or ITU, standard (V.90) and are PC and/or Macintosh
compatible. The SupraMax family of modems are internal fax/data modem solutions
that connect via the Peripheral Component Interconnect, or Industry Standard
Architecture, interface for legacy configurations, while providing an upgraded
56K connection.

     frontpath Information Appliances. SONICblue is exploring and developing a
range of Internet devices that are intended to combine its existing expertise in
home networking, consumer design and ease of use with core technology from
industry-leaders such as Transmeta, Cirrus Logic and others. frontpath's first
product, the ProGear Information Appliance, is a web pad based on Transmeta's
Crusoe processor. The Linux-based ProGear is a wireless, fully portable,
broadband-based product which combines a 10.4 inch liquid crystal display screen
with touchscreen technology and handwriting recognition and provides the full
range of media content, including e-mail, web browser, personal organizer,
customer applications, MP3s and ebooks.

     SONICblue's successful development, manufacture and marketing of its
current and future products are subject to a number of risks discussed in the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Factors That May Affect Results."

SONICBLUE'S INVESTMENTS

     In October 1999, SONICblue caused RioPort, Inc. (formerly RioPort.com,
Inc.), which was a wholly owned subsidiary of SONICblue, to sell shares of its
preferred stock to third party investors. RioPort is developing an integrated
platform for acquiring, managing and experiencing music and spoken audio
programming from the Internet. As a result, SONICblue retains a minority
investment in RioPort and accounts for its investment using the equity method.
In addition, in November 1999, SONICblue received $10.9 million for the sale to
RioPort of OneStep, LLC, a software development company. In June 2000, RioPort
sold additional preferred stock to third party investors. As part of this
financing, the Company invested an additional $10.7 million in RioPort,
maintaining its percentage ownership of RioPort. In the fourth quarter 2000,
RioPort sold additional preferred stock to third party investors. As of December
31, 2000, the Company held approximately 33% of RioPort's outstanding stock.

     In 1995, SONICblue entered into a joint foundry venture with United
Microelectronics Corporation, or UMC, to build United Semiconductor Corporation,
or USC, a semiconductor manufacturing facility in Taiwan, R.O.C. In January
2000, USC merged with UMC and, as a result of the merger, SONICblue received 252
million UMC shares in exchange for 252 million USC shares. The Company also
received a 20% stock dividend, or approximately 50.4 million shares of UMC
stock, in April 2000, increasing SONICblue's

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holdings to approximately 302 million shares of UMC stock. The Company sold 15
million shares of UMC stock in 2000 and 25 million shares in the first quarter
of 2001 on the Taiwan Stock Exchange. Under the terms of the USC merger with
UMC, 50% of the UMC shares received by SONICblue are classified as restricted
because they are subject to restrictions on their sale that lapse over a
three-year period from the date of the merger. At December 31, 2000,
approximately 126 million shares were restricted and are recorded as a long-term
investment at cost. The unrestricted shares are recorded as a current asset and
are valued at market in accordance with SFAS 115. At December 31, 2000, the
market value of both our short-term and long-term investment in UMC had declined
by $519.8 million below its original cost basis. It was determined that this
decline was related to the downturn in the semiconductor industry as a whole and
was temporary in nature due to the historically cyclical nature of the industry.
The available-for-sale portion of our investment was marked-to-market through
other comprehensive income as required by SFAS 115. Subsequent to the year-end,
the market value of our investment in UMC remained significantly below our cost.
The downturn in the semiconductor industry and the economy in general appears to
be more severe than previously anticipated. There is a great deal of uncertainty
regarding when the semiconductor industry will recover from this down cycle. The
Company is continuing to evaluate its need to reduce the value of its
investment. Should the Company conclude that the decline in value is other than
temporary, it will report a loss in other income and expense at that time. As of
March 1, 2001, SONICblue's 262 million UMC shares held as of that date were
worth approximately $410 million, based on the closing price of UMC shares on
the Taiwan Stock Exchange on that date and the U.S. dollar to New Taiwan Dollar
exchange rate prevailing on that date. The value of SONICblue's UMC shares
fluctuates based on the trading price of UMC shares on the Taiwan Stock
Exchange. No assurance can be given that SONICblue would realize the $410
million value as of March 1, 2001 if it were to liquidate its investment.

     During 2000, in addition to the further investment in RioPort, SONICblue
made a number of investments in companies that are developing technology in
areas such as semiconductors, user interfaces, networking, peripherals and
digital audio music content including ComSilica, Inc., CyberPIXIE.com, Inc.,
DataPlay, Inc., Entridia Corporation, Epic Technologies Inc., ETC Music, Inc.,
Intellon Corporation and KB Gear Interactive, Inc.

MARKETS AND STRATEGY

     SONICblue's business strategy is to identify emerging markets and
customers' needs, to use its technological expertise to quickly provide
integrated, easy to install and use, high-performance multimedia and
connectivity solutions for the PC platform, and to use its worldwide channels to
achieve broad distribution and support of its products. SONICblue aims to expand
its position as a leader in multimedia and connectivity products for the home,
enabling consumers to create, access and experience compelling new media content
from their desktops and through the Internet. SONICblue's objectives for 2001
include: capitalizing on new technologies such as digital audio over the
Internet, digital video over the Internet, information appliances, broadband
modems and home networking; expanding international sales; increasing
penetration of the market for its digital audio players; and, in connection with
its proposed acquisitions of ReplayTV and Sensory Science, expanding its digital
media products to include video and personal television.

     Recognizing the rapid conversion of consumer electronic products from
analog to digital technology, the convergence of consumer and computing systems
into new and evolving information access devices and the PC's inherent position
as the most advanced and well-positioned digital platform, SONICblue intends to
leverage its PC and consumer technology expertise to develop new products for
both computer and consumer applications that exploit these trends. Through
several recent acquisitions and investments, SONICblue has been able to add to
its technical expertise and expand its product offerings while further improving
its distribution channels and market presence both domestically and
internationally.

SALES, MARKETING, DISTRIBUTION AND CUSTOMER SUPPORT

     SONICblue sells its products through independent domestic and international
distributors and directly to retailers, mass merchants and other resellers.
SONICblue also sells its retail products in the United States through e-commerce
web sites, including its own on-line store, mail-order catalogs and national
reseller

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organizations. SONICblue is currently seeking to expand its penetration of
e-commerce, retail and mass-merchant consumer electronics channels.

     SONICblue has been making significant efforts to expand its retail sales
channels through international penetration in Europe, Latin America, and the
Asia-Pacific region, including Japan. The requirements of these regions are,
however, substantially different from one another and from the North American
market. The inability of SONICblue to successfully penetrate any of these
channels or to manage them on a profitable basis could have a material adverse
effect on future operating results. Additional information regarding geographic
areas is included in Note 11 to the Consolidated Financial Statements.

     Export sales accounted for 56%, 70% and 89% of sales in 2000, 1999 and
1998, respectively. Approximately 33% of export sales in 2000 were to affiliates
of United States customers. Our efforts to expand international distribution of
our products have historically subjected SONICblue to the risks of conducting
business internationally. Presently, our efforts to expand international
distribution of current products as well as S3 Graphic Co., Ltd., the joint
venture between VIA and wholly owned subsidiary of SONICblue, continue to
subject SONICblue to the risks of conducting business internationally, including
those set forth under "Management's Discussion and Analyss of Financial
Condition and Results of Operations -- Factors That May Affect Our
Results -- SONICblue Has Significant Exposure to International Markets."

     SONICblue maintains a customer service and technical support organization
focused on providing value to customers beyond the purchase of SONICblue's
products. In this regard, SONICblue provides on-line customer service and
technical support to retail customers via e-mail and telephone and an artificial
intelligence "wizard" accessible through SONICblue's web site, as well as
through facsimile and direct telephonic communication. SONICblue supports the
online community through its presence on the Internet, where technical support,
frequently asked questions and a searchable knowledge base can be found.

RESEARCH AND DEVELOPMENT

     SONICblue believes that continued investment in research and development
are critical to its ability to introduce, on a timely basis and at competitive
prices, new and enhanced products incorporating the latest technology and
addressing emerging market needs. SONICblue's research and development staff
consisted of 321 employees at December 31, 2000 and 181 employees at March 1,
2001, subsequent to the transfer of the graphics chips business to S3 Graphics
Co., Ltd., the joint venture between VIA and a wholly owned subsidiary of
SONICblue. SONICblue's engineers are engaged in the development of new products
such as web pads, new generations of the Rio player, home networking devices,
and other emerging PC and Internet multimedia functions. SONICblue's software
engineers are engaged in ongoing development of software and firmware drivers to
enhance the performance of video and audio accelerators, analog and digital
modems, and various information appliances, as well as upgrades to SONICblue's
proprietary software utility applications. Research and development expenses,
which included the graphics chips business, were $83.4 million, $73.9 million
and $78.6 million in the years ended December 31, 2000, 1999 and 1998,
respectively.

     SONICblue also endeavors to work closely with third parties that are
strategic to SONICblue's business. Specifically, we work with suppliers of
audio, modem and other multimedia chipsets in an effort to select the
appropriate advanced components for SONICblue's new digital media products.
SONICblue seeks to develop in a timely manner the software required to
incorporate multimedia chipsets into SONICblue's products, and SONICblue's
products into the evolving architecture and capabilities of the PC and the
Internet. SONICblue also works with leading PC hardware, operating system and
software applications suppliers in an effort to stay abreast of emerging
opportunities and new standards in the market. There can be no assurance that
SONICblue's development efforts will be successful, or that SONICblue will be
able to introduce competitive new products into the marketplace in a timely
manner.

MANUFACTURING METHODOLOGY

     SONICblue uses an international network of independent electronics assembly
subcontractors, principally located in Asia, to assemble and test its products.
SONICblue generally procures its current hardware

                                        7
<PAGE>   10

products on a turnkey basis from its subcontract manufacturing suppliers and
anticipates that, in the future, the only products not being procured primarily
on a turnkey basis will be new products in their launch phase.

     SONICblue packages the assembled products its receives from its
subcontractors with software, manuals and additional hardware components,
placing such materials in retail packaging for the retail and mass-merchant
channel. While SONICblue uses several electronics assembly subcontractors to
minimize the risk of business interruption, there can be no assurance that a
problem will not arise with one or more of these suppliers that could adversely
affect operating results.

     There can be no assurance that SONICblue will obtain sufficient sources of
supply of product to meet customer demand in the future. Obtaining sufficient
flash memory is particularly difficult during periods of high growth, and may
become substantially more difficult if SONICblue's product requirements increase
significantly.

     Although SONICblue extensively tests its software and hardware products
prior to their introduction, it is possible that design errors may be discovered
after initial product sampling, resulting in delays in volume production or
recall of products sold. The occurrence of any such errors could have a material
adverse effect on SONICblue's reputation, product introduction schedule and
operating results.

COMPETITION

     The markets in which SONICblue operates are extremely competitive, and
SONICblue expects that competition will increase. SONICblue competes directly
against a large number of suppliers of audio subsystems, PDAs, information
appliances, home networking products and PC communications products. In the
digital audio player market, competitors include Audiovoxx, Casio, Creative
Technology, and its U.S. entity, Creative Labs, Intel, Thompson Multimedia,
Samsung and Sony. In the areas of Internet appliances, home networking and
modems, SONICblue faces competition from companies such as 3Com, Compaq, D-link,
Intel, Linksys, NetGear, Netpliance, NIC, Motorola and Zoom Telephonics.
Competitors in the PDA market include Handspring, Palm, Sharp and Symbian.

     SONICblue's markets are expected to become increasingly competitive as
multimedia and connectivity functions continue to converge, the price of the
average PC declines and companies that previously supplied products providing
distinct functions, such as companies in the audio, video, modem and networking
markets, emerge as competitors across broader product categories and in the
emerging category of PC and information appliances. SONICblue may also face
competition from integrated or add-on products, such as digital phones or
digital cameras that incorporate audio player functions or PDAs that have
optional plug-in audio players.

     SONICblue believes that its ability to compete successfully depends upon a
number of factors both within and outside of its control, including product
performance, product features, product availability, price, brand strength,
quality, timing of new product introductions by SONICblue and its competitors,
the emergence of new digital audio and PC standards, customer support and
industry and general economic trends. SONICblue believes that it competes
favorably with respect to these factors. There can be no assurance that
SONICblue will have the financial resources, technical expertise or marketing,
distribution and support capabilities to compete successfully. SONICblue's
future success will be highly dependent upon the successful development and
introduction of new products that are responsive to market needs. There can be
no assurance that SONICblue will be able to successfully develop or market any
such products.

LICENSES, PATENTS AND TRADEMARKS

     SONICblue, when appropriate, files United States patent applications for
its technology. SONICblue has also built its patent portfolio substantially
through acquisitions, including patent purchases and cross-licenses as well as
through its acquisition of Diamond. SONICblue currently has a total of 96 United
States patents which it has been issued or has acquired and 27 United States
patent applications. SONICblue attempts to protect its trade secrets and other
proprietary information through agreements with its customers, suppliers,
employees and consultants, and through other security measures. Although
SONICblue intends to protect its rights vigorously,

                                        8
<PAGE>   11

there can be no assurance that these measures will be successful or that any
issued patents will provide SONICblue with adequate protection with respect to
the covered products, technology or processes.

     SONICblue has applied to the United States Patent and Trademark Office for
registration of a number of trademarks and also holds common law rights in a
number of trademarks. SONICblue has also applied for trademark registration of
some of its trademarks in certain foreign jurisdictions. There can be no
assurance that SONICblue will obtain the registrations for which it has applied.
If SONICblue's use of a registered or unregistered trademark were found to
violate a third party's common law or statutory trademark rights, SONICblue's
business could be adversely affected.

     In addition, the laws of certain countries in which SONICblue's products
are or may be developed, manufactured or sold, including China, Japan and
Taiwan, may not protect SONICblue's products and intellectual property rights to
the same extent as the laws of the United States.

BACKLOG

     Sales of SONICblue's products are often made pursuant to standard purchase
orders that are cancelable without significant penalties. In addition, purchase
orders are subject to price renegotiations and to changes in quantities of
products and delivery schedules in order to reflect changes in customers'
requirements and manufacturing availability. SONICblue's business, and to a
large and growing extent that of the entire consumer electronics and personal
computer connectivity industries, are characterized by seasonality, short lead
time orders and quick delivery schedules. In addition, SONICblue's actual
shipments depend on the manufacturing capacity of SONICblue's suppliers and the
availability of products from such suppliers. As a result of these factors,
SONICblue does not believe that its backlog at any given time is a meaningful
indicator of future sales.

EMPLOYEES

     At December 31, 2000, SONICblue employed 813 individuals, of whom 130 were
employed in operations, 321 in research and development, 169 in sales, marketing
and technical support and 193 in administration and other support functions.
Subsequent to the transfer of the graphics chips business to the joint venture
between VIA and a wholly owned subsidiary of SONICblue, at March 1, 2001,
SONICblue employed 535 individuals, of whom 78 were employed in operations, 181
in research and development, 169 in sales, marketing and technical support and
107 in administration and other support functions. Competition for personnel in
the digital media, consumer electronics, Internet appliance and home networking
industries is intense, as is competition for all categories of personnel in the
Silicon Valley where many of SONICblue's employees are located. SONICblue
believes that its future success will depend, in part, on its ability to
continue to attract, train, motivate, retain and manage highly skilled
technical, marketing and management personnel.

     None of SONICblue's employees are represented by a labor union or is
subject to a collective bargaining agreement. SONICblue believes that its
relations with its employees are good.

ITEM 2. PROPERTIES.

     The Company's principal administrative, sales, marketing, research and
development facilities in Santa Clara, California consists of one building of
approximately 150,000 square feet of space which is leased by the Company
through January 2008. The Company relocated to its Santa Clara facilities in
1997, at which time it leased and occupied both its current space and an
adjacent building also consisting of approximately 150,000 square feet. The
Company developed both buildings in partnership with a real estate developer
during 1995 and 1996. In October 1998, the Company sublet one of the buildings
for the remaining term of the lease. In June 1999, the Company assigned its
entire interest in the partnership to the developer for $7.8 million.

     The Company leases administrative facilities in San Jose, California. One
building of approximately 30,000 square feet is leased by the Company through
January 2003. In February 2000, the Company terminated the lease for a second
80,000 square foot building. Additionally, the Company leases an 83,000

                                        9
<PAGE>   12

square foot facility in Milpitas, California, primarily for assembly and
logistics, which is leased through January 2004. The Company also leases
research and development and administrative facilities in Vancouver, Washington,
expiring in May 2001 which will not be renewed, in Starnberg, Germany through
2001 and Winnersh, U.K. through May 2011, with three, five and 10-year
cancellation options, respectively. The Company also leases a 38,000 square foot
facility in Albany, Oregon, expiring in July 2002. During the first quarter of
2001, the Company entered into a new lease for a 44,000 square foot facility in
Tigard, Oregon expiring in June 2008, and plans to move its operations from its
Vancouver, Washington facility.

     The Company also leases sales or research and development offices in
Atlanta, Georgia; Dallas, Houston and Austin, Texas; Chicago, Illinois;
Huntsville, Alabama; Miami and Orlando, Florida; Billerica, Massachusetts; Red
Bank, New Jersey; and Raleigh, North Carolina. The Company leases international
sales, distribution or technical support offices in the metropolitan areas of
Tokyo, Japan; Paris, France; Seoul, South Korea; and Taipei, Taiwan as well as
warehouses in Singapore and Hong Kong in order to provide sales, distribution
and technical support to customers in the United States and Asia.

ITEM 3. LEGAL PROCEEDINGS.

     Since November 1997, a number of complaints have been filed in federal and
state courts seeking unspecified damages on behalf of an alleged class of
persons who purchased shares of SONICblue's common stock at various times
between April 18, 1996 and November 3, 1997. The complaints name as defendants
SONICblue, certain of its officers and former officers, and certain directors of
SONICblue, asserting that they violated federal and state securities laws by
misrepresenting and failing to disclose certain information about SONICblue's
business. In addition, certain stockholders have filed derivative actions in the
state courts of California and Delaware seeking recovery on behalf of SONICblue,
alleging, among other things, breach of fiduciary duties by such individual
defendants. The plaintiffs in the derivative action in Delaware have not taken
any steps to pursue their case. The derivative cases in California State court
have been consolidated, and plaintiffs have filed a consolidated amended
complaint. The court has entered a stipulated order in those derivative cases
suspending court proceedings and coordinating discovery in them with discovery
in the class actions in California State courts. On plaintiffs' motion, the
federal court has dismissed the federal class actions without prejudice. The
class actions in California State court have been consolidated, and plaintiffs
have filed a consolidated amended complaint. SONICblue has answered that
complaint. Discovery is proceeding. On January 22, 2001, four of the insurance
carriers which issued directors and officers insurance to SONICblue filed suit
against all parties named as defendants in the securities litigation, claiming
that the carriers have no obligation to provide coverage under the California
Insurance Code. While management intends to defend the actions against SONICblue
vigorously, there can be no assurance that an adverse result or settlement with
regard to these lawsuits would not have a material adverse effect on SONICblue's
financial condition or results of operations.

     SONICblue has received from the Securities and Exchange Commission a
request for information relating to SONICblue's restatement announcement in
November 1997. SONICblue has responded and intends to continue to respond to
such requests.

     SONICblue has also been defending several putative class action lawsuits
naming Diamond, which were filed in June and July 1996 and June 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain former executive officers and
directors of Diamond are also named as defendants. The plaintiffs purport to
represent a class of all persons who purchased Diamond's common stock between
October 18, 1995 and June 20, 1996, or the Class Period. The complaints allege
claims under the federal securities laws and California law. The plaintiffs
allege that Diamond and the other defendants made various material
misrepresentations and omissions during the Class Period. The complaints do not
specify the amount of damages sought. On March 24, 2000, the District Court for
the Northern District of California dismissed the federal action without
prejudice. The parties have tentatively agreed to settle this matter, subject to
final documentation and court approval, for a payment of $15.0 million.
SONICblue funded $4.5 million of the settlement on November 1, 2000. SONICblue
previously accrued this amount in connection with the merger with Diamond.
SONICblue believes that

                                        10
<PAGE>   13

Diamond's insurance covers the remaining $10.5 million of the settlement and
Diamond's insurers have funded that amount into the settlement.

     Sega Corporation initiated a claim for arbitration in Tokyo, Japan against
Diamond in December 1998. The claim arises out of an agreement entered into
between Sega and Diamond in September 1995, in which Sega agreed to provide
Diamond with Sega game software that Diamond would bundle with its 3-D graphics
board "The Edge." Sega claims that Diamond breached the parties' agreement by
failing to pay Sega a contractual minimum royalty fee for the games as set forth
in the agreement. Sega claims as damages $3.8 million in unpaid royalties and
pre-judgment interest. On May 28, 1999, Diamond responded to Sega's claims by
filing an answer in which it denied the material allegations of Sega's claims.
The parties have filed additional briefs in support of their claims and
defenses. An evidentiary hearing on this action has not yet been scheduled.
SONICblue contests the material allegations of Sega's claims. In addition,
SONICblue has pleaded that Sega's failure to provide it with 3-D optimized game
software on a timely basis adversely affected sales of The Edge. SONICblue
claims that these lost sales and profits should provide an offset to Sega's
claims in the arbitration and intends to defend the suit vigorously.

     C3 Sales, Inc. filed suit against SONICblue on October 6, 1999 in the
Harris County (Houston), Texas District Court. The petition sought a judicial
declaration that a Sales Representative Agreement entered into between C3 and
SONICblue on May 19, 1999 was a valid contract that governed the relationship
between the two parties. On November 8, 1999, SONICblue answered acknowledging
that the May 19, 1999 agreement was a contract between the two parties. C3
failed to respond to informal requests by SONICblue to dismiss the declaratory
relief action on grounds that no justiciable controversy existed between the
parties. On December 3, 1999, SONICblue filed a summary judgment motion seeking
judgment against C3 on the grounds that no issues of material fact remain to be
determined regarding the declaratory judgment sought by C3. C3 responded by
filing an amended petition raising new matters. Specifically, C3's new claims
allege that the Sales Representative Agreement applies to Diamond products, and
that certain commissions due under the agreement have not been paid. SONICblue
intends to defend this action vigorously.

     On January 6, 2000, PhoneTel Communications, Inc. filed a complaint for
patent infringement against a group of defendants, including Diamond, in the
United States District Court for the Northern District of Texas. PhoneTel
generally alleges that Diamond and the other defendants are infringing its two
patents by making, using, selling, offering to sell and/or importing digital
synthesizers, personal computers, sound cards, or console game systems. PhoneTel
does not specify which Diamond products allegedly infringe its patents.
SONICblue filed Diamond's answer to the complaint on March 28, 2000. SONICblue
believes it has meritorious defenses and intends to vigorously defend itself
against the allegations made in the complaint.

     The digital media, consumer appliance and home networking industries are
characterized by frequent litigation, including litigation regarding patent and
other intellectual property rights. SONICblue is party to various legal
proceedings that arise in the ordinary course of business. Although the ultimate
outcome of these matters is not presently determinable, management believes that
the resolution of all such pending matters will not have a material adverse
effect on SONICblue's financial position or results of operations.

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

     Not applicable.

                                        11
<PAGE>   14

                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

     Our common stock is traded on the Nasdaq National Market under the symbol
"SBLU." SONICblue was incorporated as S3 Incorporated on January 9, 1989 and
changed its name to SONICblue Incorporated in November 2000. Through November
14, 2000, our common stock was traded on the Nasdaq National Market under the
symbol "SIII." The following table indicates the range of the high and low sales
prices on Nasdaq as reported in its consolidated transaction reporting system.

<TABLE>
<CAPTION>
                                                              HIGH      LOW
                                                             ------    ------
<S>                                                          <C>       <C>
1999
  First Quarter............................................  $ 9.19    $ 6.44
  Second Quarter...........................................    9.75      6.47
  Third Quarter............................................   12.41      8.94
  Fourth Quarter...........................................   11.56      8.38
2000
  First Quarter............................................   24.44     11.16
  Second Quarter...........................................   19.75     12.06
  Third Quarter............................................   14.81      8.22
  Fourth Quarter...........................................   10.50      3.63
</TABLE>

     As of December 31, 2000, there were approximately 831 stockholders of
record of the Company's common stock. The Company has never declared or paid
cash dividends on its capital stock and does not anticipate paying any cash
dividends in the foreseeable future. The Company currently intends to retain
future earnings for the development of its business.

                                        12
<PAGE>   15

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31,
                                            -------------------------------------------------------
                                               2000        1999       1998        1997       1996
                                            ----------   --------   ---------   --------   --------
                                              (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
<S>                                         <C>          <C>        <C>         <C>        <C>
STATEMENT OF INCOME DATA
Net sales.................................  $  536,704   $352,583   $ 224,639   $436,359   $439,243
Gross margin (loss).......................     (11,912)    45,422      (2,072)   135,174    168,876
Research and development expenses.........      83,433     73,896      78,566     78,612     63,382
Selling, marketing and administrative
  expenses................................     126,852     52,832      41,926     55,879     48,800
Restructuring expense.....................       6,694         --       6,109         --         --
Other operating expense(1)................          --      6,700      35,226     17,180         --
Amortization of goodwill and
  intangibles.............................      44,440     12,156          --         --         --
Income (loss) from operations.............    (273,331)  (100,162)   (163,899)   (16,497)    56,694
Net income (loss).........................  $  312,828   $(30,780)  $(113,204)  $  8,878   $ 41,588
Net income per share
  Basic...................................  $     3.46   $  (0.52)  $   (2.22)  $   0.18   $   0.88
  Diluted(2)..............................  $     3.13   $  (0.52)  $   (2.22)  $   0.17   $   0.81
Shares used in computing per share
  amounts:
  Basic...................................      90,390     59,244      51,078     49,519     47,460
  Diluted(2)..............................     101,150     59,244      51,078     51,740     52,451
BALANCE SHEET DATA
Cash and equivalents......................  $   36,582   $ 45,825   $  31,022   $ 90,484   $ 94,616
Short-term investments....................     237,690     58,918      88,553     27,186     62,768
Working capital...........................     161,511    100,149     152,244    209,993    225,550
Total assets..............................   1,099,305    722,647     325,801    492,854    485,172
Long-term obligations.....................       4,040     12,010      13,837     27,070     20,852
Convertible subordinated notes............     103,300    103,500     103,500    103,500    103,500
Stockholders' equity......................     671,653    382,633     163,530    270,840    260,321
</TABLE>

---------------
(1) Other operating expense for 1999 includes a write-off of acquired
    technologies of $6.7 million. Other operating expense for 1998 includes a
    write-off of acquired technologies of $8.0 million and a charge for
    impairment of long-lived assets of $27.2 million. Other operating expense
    for 1997 includes a charge for impairment of long-lived assets of $17.2
    million.

(2) Diluted earnings per share includes the effect of incremental shares
    issuable upon the conversion of the convertible subordinated notes, the
    dilutive effect of outstanding options and an adjustment to net income for
    the interest expense (net of income taxes) related to the notes unless the
    impact of such conversion is anti-dilutive. The effect of the conversion was
    anti-dilutive in 1999 and 1998.

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

     The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and
related Notes included elsewhere in this Report.

     When used in this discussion, the words "expects," "anticipates,"
"believes," "estimates" and similar expressions are intended to identify
forward-looking statements. These statements, which include statements as to
SONICblue's intention to continue to supply and support its OEM customers,
channel partners and end-users for existing Diamond-Multimedia branded PC
graphics add-in cards, the timing of availability and functionality of products
under development, product mix, the percentage of net sales represented by any
particular new or current product, trends in average selling prices, the
percentage of export sales and sales to strategic customers, trends in gross
margin, the availability and cost of products from the Company's suppliers,
expectations regarding timing and completion of restructuring plans and
expectations regarding working
                                        13
<PAGE>   16

capital, capital expenditures, capital requirements and adequacy of capital
resources, are subject to risks and uncertainties that could cause actual
results to differ materially from those projected. These risks and uncertainties
include, but are not limited to, those risks discussed below, as well as risks
relating to SONICblue's ability to develop and timely introduce products that
address market demands, manufacturing difficulties, SONICblue's ability to work
with strategic partners and OEMs, the ability of the Company to obtain and
retain customers, the impact of alternative technological advances and
competitive products, the value of the Company's shares of UMC common stock and
declines in the semiconductor industry, market fluctuations, developments in and
expenses relating to litigation, SONICblue's ability to integrate acquired
businesses and in a timely manner, the costs of integrating acquired businesses
and technologies, and the matters discussed in "Factors that May Affect
Results." These forward-looking statements speak only as of the date hereof. The
Company expressly disclaims any obligation or undertaking to release publicly
any updates or revisions to any forward-looking statements contained herein to
reflect any change in the Company's expectations with regard thereto or any
change in events, conditions or circumstances on which any statement is based.

OVERVIEW

     SONICblue Incorporated ("SONICblue" or the "Company"), previously known as
S3 Incorporated, designs, develops and markets products for the digital media,
consumer electronics, internet appliance and home networking markets. The
Company's products include the Rio line of digital music players, the Fire
series of NT workstation 3-D graphics accelerators, the HomeFree line of home
networking products and the Supra line of modems. Prior to the transfer in
January 2001 of its graphics chips business to a joint venture between VIA
Technologies, Inc. ("VIA") and a wholly owned subsidiary of the Company, the
Company was a leading supplier of graphics and multimedia accelerator subsystems
for PCs for over ten years.

     In September 1999, SONICblue made a significant strategic shift by merging
with Diamond Multimedia Systems, Inc. ("Diamond"), an established PC original
equipment manufacturer, or OEM, and retail provider of communications and home
networking solutions, PC graphics and audio add-in boards, digital audio players
and Internet appliances. The transaction was accounted for as a purchase, and,
accordingly, the results of operations of Diamond and the estimated fair value
of assets acquired and liabilities assumed are included in the Company's
consolidated financial statements as of September 24, 1999, the effective date
of the purchase.

     In October 1999, SONICblue announced that it caused RioPort, Inc.
("RioPort"), formerly RioPort.com Inc., which was a wholly owned subsidiary, to
sell shares of its preferred stock to third party venture capital and strategic
investors. RioPort is developing an integrated platform for acquiring, managing
and experiencing music and spoken audio programming from the Internet. As a
result of the preferred stock financing, the Company retained a minority
investment in RioPort and accounts for its investment using the equity method.
In addition, in November 1999, the Company received $10.9 million for the sale
of OneStep, LLC to RioPort. In June 2000, RioPort sold additional preferred
stock to third party investors. As part of this financing, the Company invested
an additional $10.7 million in RioPort, maintaining its percentage ownership of
RioPort. In the fourth quarter of 2000, RioPort sold additional preferred stock
to third party investors. As of December 31, 2000, SONICblue held approximately
33% of RioPort's outstanding stock.

     In November 1999, the Company established a joint venture with VIA to bring
high-performance integrated graphics and core logic chip sets to the volume OEM
desktop and notebook PC markets. The joint venture, S3-VIA Inc., was jointly
funded, with access to both SONICblue's and VIA's technology as well as
distribution rights for developed products between SONICblue and VIA. At
December 31, 2000, SONICblue owned 50.1% of the voting common stock of S3-VIA
and accordingly, SONICblue consolidated the accounts of S3-VIA in its
consolidated financial statements. In January 2001, SONICblue's interest in
S3-VIA was transferred, along with SONICblue's graphics chip business, to S3
Graphics Co., Ltd., another joint venture between VIA and a wholly owned
subsidiary of SONICblue, as described below.

     In August 2000, the Company began the shutdown of its Diamond
Multimedia-branded graphics add-in board business. The Company will continue to
supply and support its OEM customers, channel partners and end-users for the
existing line of Diamond Multimedia-branded PC graphics add-in cards, but has
ceased

                                        14
<PAGE>   17

development of follow-on products. The shut-down did not extend to the Company's
professional graphics division, headquartered in Germany, which continues to
develop and market its line of Fire GL graphics accelerators. As discussed
below, the Company signed an Asset Purchase Agreement with ATI Technologies to
sell the professional graphics division.

     In September 2000, SONICblue formed frontpath, Inc. as a wholly owned
subsidiary to develop Information Appliances, such as accessible wireless
portable devices to allow businesses and consumers to live connected at home, at
work and at play.

     In November 2000, SONICblue acquired U.K. digital audio equipment
manufacturer Empeg Limited, known as empeg, for $1.9 million. This acquisition
was accounted for as a purchase. One of the first companies to design and bring
to market digital audio players for automobiles, empeg has become a part of
SONICblue's Rio division, and empeg's technology formed the basis for the
recently introduced Rio Car audio player.

     In January 2001, SONICblue completed the transfer of its graphics chips
assets to S3 Graphics Co., Ltd., a joint venture between VIA and a wholly owned
subsidiary of SONICblue. The joint venture will manufacture and distribute
graphics products and conduct related research and development activities.
Pursuant to the joint venture agreement with VIA, SONICblue received 13 million
shares of SONICblue common stock as payment, and the joint venture assumed
certain liabilities relating to the graphics chips business. Upon the occurrence
of events specified in the investment agreement between SONICblue and VIA,
SONICblue must pay specified liquidated damages, subject to a maximum damages
cap. Under the joint venture agreement, SONICblue will also receive earn-out
payments if the new venture meets specified profitability goals. SONICblue,
through its wholly owned subsidiary, owns all of the outstanding shares of Class
A stock of the joint venture, which represents 50% of the voting power of the
joint venture with respect to the election of directors and 0.1% of the economic
interest of the joint venture. At closing, SONICblue issued to a wholly owned
subsidiary of VIA a warrant to purchase up to 2 million shares of SONICblue
common stock at an exercise price of $10.00 per share, for an aggregate exercise
price of $20 million.

     In February 2001, SONICblue announced that it signed a definitive agreement
to acquire Sensory Science Corporation, whose assets include the Go Video,
California Audio Labs and Rave brands, as well as an exclusive distribution
agreement with Loewe Opta GmbH of Germany. Pending the consummation of the
acquisition of Sensory Science Corporation, SONICblue has made a loan to Sensory
Science in the amount of $3 million and has obtained a warrant to purchase
5,357,143 shares of Sensory Science common stock.

     In March 2001, SONICblue signed a definitive agreement to acquire ReplayTV,
Inc., a developer of personal television technology. Under the terms of the
agreement, SONICblue will issue an aggregate of 15.5 million shares of common
stock and options and warrants to purchase shares of SONICblue common stock in
exchange for all of ReplayTV's outstanding equity, and ReplayTV will become a
wholly owned subsidiary of SONICblue. The agreement also provides that if the
value of the SONICblue common stock to be issued to stockholders of ReplayTV at
the closing of the transaction is less than $80 million, ReplayTV may terminate
the agreement unless SONICblue, at its option, either pays additional cash or
issues additional shares to bring the value at closing to $80 million. In
connection with the proposed acquisition of ReplayTV, SONICblue has made loans
to Replay in the amount of $10 million and agreed to loan ReplayTV up to an
additional $6 million.

     In March 2001, SONICblue announced the proposed sale to ATI Technologies of
its professional graphics division, based in Starnberg, Germany, which produces
the Fire GL line of graphics accelerators. Under the terms of an Asset Purchase
Agreement, SONICblue will receive $2.7 million in cash and is eligible to
receive further financial consideration of up to $7.3 million, contingent upon
the Fire GL graphics business achieving future performance targets.

RESULTS OF OPERATIONS

     The results of operations of SONICblue include the results of Diamond
beginning in September 1999 and the results of empeg beginning in November 2000.
The results also include the results from the Diamond Multimedia-branded
graphics add-in board business (since the acquisition of Diamond) and its
graphics chip

                                        15
<PAGE>   18

business. The Company began the shut down of its Diamond Multimedia-branded
graphics add-in boards business in August 2000, and it transferred the assets of
its graphics chips business to a joint venture in January 2001. See Note 17 to
the consolidated financial statements in Item 8 for unaudited pro forma
information giving effect to the transfer of the graphics chips assets to the
joint venture.

     The following table sets forth for the years indicated certain financial
data as a percentage of net sales:

<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                              -----------------------
                                                              2000     1999     1998
                                                              -----    -----    -----
<S>                                                           <C>      <C>      <C>
Net sales...................................................  100.0%   100.0%   100.0%
Cost of sales...............................................  102.2     87.1    100.9
                                                              -----    -----    -----
Gross margin (loss).........................................   (2.2)    12.9     (0.9)
Operating expenses:
  Research and development..................................   15.5     21.0     35.0
  Selling, marketing and administrative.....................   23.6     15.0     18.7
  Restructuring expense.....................................    1.3       --      2.7
  Other operating expense...................................     --      1.9     15.7
  Amortization of goodwill and intangibles..................    8.3      3.4       --
                                                              -----    -----    -----
          Total operating expenses..........................   48.7     41.3     72.1
                                                              -----    -----    -----
Income (loss) from operations...............................  (50.9)   (28.4)   (73.0)
  Gain on sale of joint venture.............................    2.7      6.4     11.9
  Gain (loss) on UMC Investment, net........................  162.0       --       --
  Gain on sale of other investments.........................    1.1       --       --
  Equity income (loss) of investees.........................   (2.1)      --      7.8
  Other income (expense), net...............................   (2.1)    (0.3)    (2.4)
                                                              -----    -----    -----
Income (loss) before income taxes...........................  110.7%   (22.3)%  (55.7)%
Income tax expense (benefit)................................   52.4    (13.6)    (5.3)
                                                              -----    -----    -----
Net income (loss)...........................................   58.3%    (8.7)%  (50.4)%
                                                              =====    =====    =====
</TABLE>

  Net Sales

     The Company's products are used in, and its business is dependent upon, the
PC industry and growth of the Internet. Sales of the Company's products are
primarily in the United States, Asia and Europe. Net sales were $536.7 million
in 2000, an increase of 52% from $352.6 million in 1999. Net sales increased
from 1999 to 2000 because of the acquisition of Diamond in 1999 and the
inclusion of the revenue of Diamond products in the Company's financial results
of operations beginning on September 24, 1999. Net sales in 2000 consisted
primarily of the Company's graphics chips, Diamond brand graphics add-in cards,
modem and communications products and Rio digital audio players, while net sales
for 1999 consisted primarily of the Company's graphics chips. Net sales for 2000
for the Company's graphics chips were $226.9 million.

     Sales increased from 1998 to 1999 because of the acquisition of Diamond and
the inclusion of the revenue of Diamond products in the Company's financial
results of operations beginning on September 24, 1999. In addition, the Company
introduced products into new markets such as add-in graphics cards and replaced
older generation products in the desktop and laptop PC markets, resulting in an
increased volume of product shipments and higher average selling prices.

     The Company expects that the percentage of its net sales represented by any
one product or type of product may change significantly from period to period as
new products are introduced and existing products reach the end of their life
cycles. Due to competitive price pressures, the Company's products experience
declining average selling prices over time, which at times can be substantial.

     Export sales accounted for 56%, 70% and 89% of net sales in 2000, 1999 and
1998, respectively. Approximately 33% of export sales in 2000 were to affiliates
of United States customers. The Company expects that export sales will continue
to represent a significant portion of net sales, although there can be no

                                        16
<PAGE>   19

assurances that export sales as a percentage of net sales will remain at current
levels. All sales transactions are denominated in U.S. dollars.

     Sales to original equipment manufacturers, or OEMs, were significant to net
sales in 2000. One OEM customer accounted for 21% of net sales in 2000. Two
customers accounted for 19% and 10% of net sales in 1999. Three customers
accounted for 39%, 14% and 13% of net sales in 1998. The Company expects a
significant portion of its future sales to remain concentrated within a limited
number of strategic customers. Sales to any particular customer may fluctuate
significantly from quarter to quarter.

  Gross Margin

     The Company had a negative gross margin of 2% in 2000, a positive gross
margin of 13% in 1999 and a negative gross margin of 1% in 1998. The negative
gross margin in 2000 was primarily the result of lower margin products sold by
the Rio and Access divisions and a $3.4 million charge for the write-down of
inventory relating to the shutdown of the Diamond Multimedia branded graphics
add-in board business. Another factor resulting in decreased gross margin was
the highly competitive pricing pressures in the market for mainstream and
entertainment graphics accelerators. This was partially offset by improving
margins on the Company's desktop chips and communications products.

     Gross margin in 1999 as compared to gross margin in 1998 was favorably
impacted by an increase in average selling prices and an increase in sales of
products with higher margins (primarily graphics chips), partially offset by
charges for excess and obsolete inventory and lower of cost or market reserves
made in 1999.

     The negative gross margin in 1998 was a result of decreases in overall
average selling prices of the ViRGE and Trio family of accelerators. Also
affecting the negative gross margin were charges for excess and obsolete
inventory, lower of cost or market reserves established for the Company's 2-D
and 3-D products, a $4.0 million charge for underutilized prepaid production
capacity and yield losses.

     In the future, the Company's gross margins may be adversely affected by
increased competition and related decreases in average selling prices
(particularly with respect to older generation products), timing of volume
shipments of new products, the availability and cost of products from the
Company's suppliers, changes in the mix of products sold and the extent to which
the Company incurs additional licensing fees. Negative gross margins could
continue in the near-term future.

  Research and Development Expenses

     The Company has made and intends to continue to make significant
investments in research and development to remain competitive by developing new
and enhanced products. Research and development expenses were $83.4 million in
2000, $73.9 million in 1999 and $78.6 million in 1998.

     Research and development expenses increased by 13% from 1999 to 2000 as a
result of inclusion of headcount and related expenses associated with the
Diamond acquisition, which were included in the Company's results of operations
for the entire year. Research and development expenses decreased by 6% from 1998
to 1999 as a result of an increased focus on core technology and products.
Concentration of research and development efforts resulted in lower headcount
and related costs. Write-offs of idle and excess capital equipment in 1998
resulted in lower depreciation and maintenance charges in 1999. Also, research
and development expenses for 1998 reflect approximately $3.0 million in charges
for the Company's discontinued audio and communications product lines and the
write-offs of idle, excess and obsolete capital equipment associated with
research and development projects terminated during the year.

  Selling, Marketing and Administrative Expenses

     Selling, marketing and administrative expenses were $126.9 million in 2000,
$52.8 million in 1999 and $41.9 million in 1998. The 140% increase in selling,
marketing and administrative expenses from 1999 to 2000 was due primarily to the
integration and combination of selling, marketing and administrative headcount
and related expenses associated with the acquisition of Diamond and Empeg
Limited. Other factors that affected

                                        17
<PAGE>   20

marketing expenses were costs associated with the refocusing of the Company's
business, including its name change and image in November 2000.

     The 26% increase in selling, marketing and administrative expenses from
1998 to 1999 was primarily due to the acquisition of Diamond in October 1999 and
additional sales, marketing and administrative expenses required to support the
increase in revenue from 1998 to 1999. As a percentage of revenue, selling,
marketing and administrative expenses decreased from 19% in 1998 to 15% in 1999.

  Restructuring Expense

     In August 2000, the Company adopted a restructuring plan relating to the
shutdown of its Diamond Multimedia-branded add-in board business to reflect its
long term strategy and focus. Restructuring expenses of $6.7 million in 2000
related to the shutdown included write-off of intangibles, facilities closure
expenses and personnel severance compensation and related expenses. As part of
the restructuring, the Company also wrote off $3.4 million of inventory, through
cost of sales. At December 31, 2000, the reserve remaining for these items was
$2.1 million. Aside from the original write-off of intangibles, reductions in
the reserve were the result of cash payments. The Company expects the plan to be
completed by the end of 2001.

     In July 1998, the Company implemented a restructuring plan, resulting in a
charge of $6.1 million, in order to align resources with a new business model
and to lower the Company's overall cost structure. In connection with the
restructuring, the Company reduced its headcount and consolidated facilities.
Severance and related benefits related to the reduction of approximately 70
employees were paid by the end of the second quarter of 1999. The number of
temporary employees and contractors used by the Company was also reduced. The
restructuring expense included the write-off and write-down in carrying value of
equipment, which consists primarily of workstations, personal computers and
furniture that are no longer utilized in the Company's operations. These assets
were written down to their estimated fair value less cost to sell. Facility
closure expenses were incurred as a result of the vacating of one of two leased
buildings at the Company's headquarters and include leasehold improvements,
furniture, fixtures and network costs. The Company completed its move in 1999.

  Other Operating Expense

     Other operating expense in 1999 included a write-off of acquired
technologies of $6.7 million related to the purchase of Diamond on September 24,
1999. This was determined through valuation techniques generally used by
appraisers in the high-technology industry and was immediately expensed in the
period of acquisition because technological feasibility had not been established
and no alternative use had been identified.

     Other operating expense in 1998 included a write-off of acquired
technologies of $8.0 million and a charge for impairment of long-lived assets of
$27.2 million.

  Amortization of Goodwill and Intangibles

     Amortization of goodwill and intangibles increased from $12.2 million in
1999 to $44.4 million in 2000 primarily due to the full year of amortization of
goodwill and intangibles recorded as a result of the Diamond acquisition. The
Diamond acquisition was effective in September 1999, at which time the
amortization began.

  Gain on Sale of Manufacturing Joint Venture

     On December 31, 1997, the Company entered into an agreement with United
Microelectronics Corporation, or UMC, to sell to UMC 80 million shares of stock
of United Semiconductor Corporation, or USC, for a price of 2.4 billion New
Taiwan Dollars. The Company received the sales price (approximately $68.0
million) in January 1998 upon closing. The gain on the sale of stock in USC
recorded in 1998 was $26.6 million.

     In June 1999, the Company amended its agreement with UMC. Under the terms
of the amended agreement, UMC has agreed to pay the Company, subject to certain
conditions, 1.4 billion New Taiwan Dollars (totaling approximately $37.2 million
in cash over the period that the cash was received) and the

                                        18
<PAGE>   21

Company has agreed to release UMC from contingencies associated with the sale of
80 million shares of stock of USC in January 1998 (described in the preceding
paragraph) and to grant a license to UMC for 29 patents covering multimedia
products and integrated circuit manufacturing technology for use in products
manufactured by UMC. The Company recognized the gain on this transaction over
five fiscal quarters beginning in the quarter ended June 30, 1999, as payments
were received. In 1999, the gain recognized on the sale of the stock in USC was
$22.4 million. In 2000, the gain recognized on the sale of stock in USC was
$14.7 million.

  Gain on UMC Investment, net

     In June 1999, UMC announced a foundry consolidation plan whereby USC,
United Integrated Circuits Corporation, United Silicon Incorporated and UTEK
Semiconductor Corporation would be merged into UMC. Under the terms of the
consolidation plan, each of the Company's shares in the USC joint venture would
be exchanged for one share of UMC. On January 4, 2000, the Company's 252 million
shares of USC were exchanged for 252 million shares of UMC stock. The Company
recorded a gain on the transfer of the shares of $884.2 million to recognize the
difference in the carrying value of its investment in USC, a privately held
company, and the fair market value of the UMC, a publicly traded company, shares
on the date of the transfer. Approximately half of the shares received are
subject to sale restrictions and are carried at market value as of January 4,
2000 as long-term assets in the accompanying balance sheet at December 31, 2000.
As the remaining shares are freely tradable, the investment is adjusted to fair
market value in accordance with SFAS 115 and classified as short-term
investments.

     The Company received a 20% stock dividend, or approximately 50.4 million
shares of UMC stock, in April 2000, increasing the Company's holdings to
approximately 302 million shares of UMC stock. The Company sold 10 million
shares of UMC stock in August 2000 on the Taiwan Stock Exchange receiving net
proceeds of $25.1 million. The Company sold 5 million shares of UMC stock in
December 2000 on the Taiwan Stock Exchange receiving net proceeds of $6.4
million. These transactions resulted in an aggregate net loss of $10.8 million.
At December 31, 2000, approximately 161 million shares are classified as a
current asset with approximately 126 millions shares classified as a long-term
asset.

     At December 31, 2000, the market value of both our short-term and long-term
investment in UMC had declined $519.8 million below its original cost basis. It
was determined that this decline was related to the downturn in the
semiconductor industry as a whole and was temporary in nature due to the
historically cyclical nature of the industry. The available-for-sale portion of
our investment was marked-to-market through other comprehensive income as
required by SFAS 115.

     Subsequent to the year-end, the market value of our investment in UMC
remained significantly below our cost. The downturn in the semiconductor
industry and the economy in general appears to be more severe than previously
anticipated. There is a great deal of uncertainty regarding when the
semiconductor industry will recover from this down cycle. The Company is
continuing to evaluate its need to reduce the value of its investment. Should
the Company conclude that the decline in value is other than temporary, it will
report a loss in other income and expense at that time.

  Gain on Sale of Other Investments

     In fiscal year 2000, the Company recognized a gain in the amount of $5.9
million from the sale of certain non-strategic investments in corporate equity
securities. There were no comparable transactions in either fiscal 1999 or 1998.

  Equity Income/(Loss) of Investees

     Investments in entities in which the Company does not have control, but has
the ability to exercise significant influence over operating and financial
policies, are accounted for by the equity method. In 2000, the Company's share
of losses in these entities was $11.4 million. In 1999, the loss was $0.05
million. In 2000, the loss was principally due to the Company's share of losses
from Rioport, Inc. In 1998, the Company recognized income of $17.5 million,
attributable to its investment in USC.

                                        19
<PAGE>   22

  Interest Expense

     Interest expense increased from $6.2 million in 1998 to $7.2 million in
1999 to $9.2 million in 2000, primarily due to the Company's increased
borrowings on its bank facility.

  Other Income (Expense), Net

     Other income (expense), net changed from a net other income of $6.3 million
in 1999 to a net expense of $1.9 million in 2000. This was the result of higher
foreign currency translation losses in 2000 and lower interest income due to the
decreasing balance of short-term investments. Other income (expense), net
changed from net other expenses in 1998 of $0.9 million to net other income in
1999 primarily due to non-recurring write-offs of certain equity investments and
royalty expenses that occurred in 1998 and an increase in sublease income in
1999 as well as a decrease in interest income due to decreasing balances of
short-term investments.

INCOME TAXES

     The Company's effective tax rate for 2000 was 47.4%, compared to the
benefit tax rates of 60.9% and 9.6% for 1999 and 1998, respectively. The
effective tax rate for 2000 reflects the effects of the gain on the UMC shares
and the inability to use the goodwill amortization and foreign losses to reduce
taxable income. The effective tax rate for 1999 reflects the expected benefits
of current year and prior year net operating loss and tax credit carryovers. The
effective tax rate for 1998 reflects the expected benefits of current year loss
carrybacks net of the establishment of a valuation allowance in 1998 against the
beginning of the year balance of net deferred tax assets.

LIQUIDITY AND CAPITAL RESOURCES

     Cash used for operating activities was $221.2 million in 2000 and consisted
primarily of the Company's operating income of $312.8 million, which included a
non-cash gain on its UMC investment of $869.4 million, and other investments of
$20.2 million. This was partially offset by non-cash charges including deferred
income taxes of $278.2 million, amortization and depreciation of $64.8 million
and equity in losses of investee of $11.4 million.

     Cash used for operating activities was $67.5 million in 1999 and consisted
primarily of the Company's operating loss of $30.8 million, an increase in
deferred income taxes of $61.7 million and an increase in inventories of $34.7
million. These were partially offset by non-cash charges including depreciation,
amortization and write-off of acquired technologies and by decreases in accounts
receivable and prepaid expenses and other and increases in accounts payable,
accrued liabilities and income taxes payable.

     Cash used for operating activities was $9.3 million in 1998. The Company's
operating loss of $113.2 million was offset by non-cash charges including
deferred income taxes, depreciation, amortization, loss on the disposal of
equipment, write-off of prepaid production capacity, the utilization of
production capacity rights, write-off of impaired assets and the write-off of
acquired technologies. The Company sold a portion of its interest in USC during
1998 and recognized a gain of $26.6 million. In addition the Company recognized
$17.5 million in income from its 15.75% equity investment in USC. The non-cash
charges were offset by decreases in accounts receivable and inventories of $36.8
million and $60.5 million, respectively. Accounts receivable decreased as a
result of lower net sales by the Company, while inventories decreased as the
result of lower production volumes and charges taken during 1998 for excess and
obsolete inventory, lower of cost or market reserves and yield losses. Accounts
payable decreased as a direct result of lower inventory purchases.

     Investing activities provided cash of $29.5 million in 2000 and consisted
primarily of sales and maturities of short-term investments, including a portion
of the Company's UMC investment, of $170.2 million, cash received related to the
sale of USC shares of $14.7 million, offset by the additional purchase cost of
merging with Diamond of $6.3 million, purchases of short-term investments, and
equity investments in technology companies and other acquisitions of $140.2
million and purchases of property and equipment of $8.9 million. Investing
activities provided cash of $38.7 million in 1999 and consisted primarily of
maturities of short-term investments of $148.9 million, cash received from UMC
related to the sale of USC shares of $22.4 million and

                                        20
<PAGE>   23

cash received from the sale of investment in real estate partnership of $7.8
million, offset by purchases of short-term investments of $107.7 million, the
merger with Diamond, net of cash acquired of $22.5 million and net purchases of
property and equipment of $6.6 million. Investing activities used cash of $38.9
million in 1998 and consisted primarily of $40.0 million used in a patent
purchase and cross-licensing agreement with Cirrus Logic, Inc., $5.9 million of
property and equipment purchase, and $125.4 million of short-term investment
purchases, offset by $66.7 million of maturities of short-term investments and
$68.0 million from the sale of a portion of the Company's joint venture in USC.
The Company expects capital requirements for 2001 to be consistent with those
for 2000.

     Financing activities provided cash of $182.5 million in 2000 and consisted
of sales of common stock of $162.0 million, including proceeds from the private
sale of stock to VIA and borrowings of notes payable in the amount of $20.5
million. Financing activities provided cash of $38.7 million in 1999 and
consisted of sales of common stock, net, including $34.4 million received from
the sale of stock to three foreign investors, and the sale of a warrant to
Intel, offset partially by repayments of notes payable. Financing activities
used cash of $11.3 million in 1998 and consisted primarily of repayments of
notes payable and equipment financing, offset partially by sales of common
stock, net.

     In 1995, the Company entered into two long-term manufacturing capacity
arrangements. The Company entered into an agreement with UMC and Alliance
Semiconductor Corporation to form USC, a separate Taiwanese company, for the
purpose of building and managing a semiconductor manufacturing facility in the
Science Based Industrial Park in Hsin Chu City, Taiwan, R.O.C. The Company
invested $53.0 million in 1996 and $36.4 million in 1995 for its 23.75% equity
interest. The facility commenced production utilizing advanced submicron
semiconductor manufacturing processes in late 1996. In January 1998, the Company
reduced its equity interest to 15.75% through the sale of a portion of its USC
shares, and received approximately $68 million in cash. In January 2000, the
Company's USC shares were exchanged for 252 million UMC shares. The Company has
the right to purchase up to 31.25% of the output from the foundry. In addition,
the Company expanded and formalized its relationship with TSMC to provide
additional capacity over the 1996 to 2000 timeframe. During the second quarter
of 1999, the Company and TSMC agreed to extend the capacity term of the
agreement two years to 2002. The agreement with TSMC requires the Company to
make certain annual advance payments to be applied against the following year's
capacity. The Company signed promissory notes to secure these payments, which
totalled $9.6 million as of December 31, 1999. In July 2000, the Company
terminated the "take or pay" contract with TSMC and its foundry relationship
with UMC. The Company received a refund of approximately $4.8 million and the
notes payable were cancelled.

     Working capital at December 31, 2000 and December 31, 1999 was $161.5
million and $100.1 million, respectively. At December 31, 2000, the Company's
principal sources of liquidity included cash and equivalents of $36.6 million
and $9.0 million in short term investments. In addition, the Company held shares
of UMC (classified as a current asset) valued at $228.7 million at December 31,
2000 based upon then existing New Taiwan Dollar to U.S. Dollar exchange rates
and UMC's market prices on the Taiwan Stock Exchange. Using the market value and
exchange rate at March 1, 2001, these shares were valued at $238.0 million. At
December 31, 2000, the Company had short-term lines of credit and bank credit
facilities totaling $79.3 million, of which approximately $6.6 million was
unused and available. The Company believes that its available funds will satisfy
the Company's projected working capital and capital expenditure requirements for
at least the next 12 months.

     The Company is currently a party to certain legal proceedings. Litigation
could result in substantial expense to the Company. See "Item 3. Legal
Proceedings."

RECENT ACCOUNTING PRONOUNCEMENTS

     As of January 1, 2001, the Company adopted Financial Accounting Standards
Board Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities (Statement 133), which was issued in June 1998, and its amendments
Statement 137, Accounting for Derivative Instruments and Hedging
Activities-Deferral of the

                                        21
<PAGE>   24

Effective Date of FASB No. 133 and 138, Accounting for Derivative Instruments
and Certain Hedging Activities issued in June 1999 and June 2000, respectively
(collectively referred to as Statement 133).

     As a result of the adoption of Statement 133, the Company will recognize
all derivative financial instruments, such as foreign exchange contracts, in the
consolidated financial instruments at fair value regardless of the purpose or
the intent for holding the instrument. Changes in the fair value of derivative
financial instruments are either recognized periodically in income or in
stockholders' equity as a component of comprehensive income depending on whether
the derivative financial instrument qualifies for hedging accounting, and if so,
whether it qualifies as a fair value hedge or cash flow hedge. Generally,
changes in fair values of derivatives accounted for as fair value hedges are
recorded in income along with the portions of the changes in the fair values of
the hedged items that relate to the hedged risk(s). Changes in fair values of
derivatives accounted for as cash flow hedges, to the extent they are effective
as hedges, are recorded in other comprehensive income net of deferred taxes.
Changes in fair value of derivatives used as hedges of the net investment in
foreign operations are reported in other comprehensive income as part of the
cumulative translation adjustment. Changes in fair value of derivatives not
qualifying as hedges are reported in income.

     In the fourth quarter of 2000, the Company implemented Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," or SAB 101,
retroactively to January 1, 2000. SAB 101 requires that the following criteria
must be met before revenues can be recorded: (a) persuasive evidence that an
arrangement exists, (b) delivery has occurred or services have been rendered,
(c) the seller's price to the buyer is fixed or determinable, and (d)
collectibility is reasonably assured. There was no cumulative effect associated
with implementing SAB 101.

     In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation, an interpretation of APB
Opinion No. 25. FIN 44 clarifies the application of Opinion No. 25 for (a) the
definition of an employee for purposes of applying Opinion No. 25, (b) the
criteria for determining whether a plan qualifies as a non-compensatory plan,
(c) the accounting consequences of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. FIN 44 became effective
July 2, 2000, but certain conclusions cover specific events that occur after
either December 15, 1998, or January 12, 2000. The adoption of FIN 44 did not
have a material impact on the Company's financial position, results of
operation, or cash flows.

                                        22
<PAGE>   25

                        FACTORS THAT MAY AFFECT RESULTS

SONICBLUE HAS RECENTLY CHANGED THE FOCUS OF ITS BUSINESS AND MAY BE UNSUCCESSFUL
OR EXPERIENCE DIFFICULTIES IN IMPLEMENTING THIS CHANGE. IF THIS OCCURS,
SONICBLUE MAY NOT BE ABLE TO ACHIEVE OPERATING PROFITABILITY.

     In January 2001, SONICblue completed the transfer of its graphics chips
business to S3 Graphics Co., Ltd., a joint venture between VIA Technologies,
Inc. and a wholly owned subsidiary of SONICblue. SONICblue is realigning its
resources to focus on its digital media, consumer electronics, Internet
appliance and home networking businesses. SONICblue has a limited operating
history with these businesses, and its shift in focus may prove to be
unsuccessful. In addition, the industry is new and continually evolving.
SONICblue's digital media, consumer electronics, Internet appliance and home
networking businesses compete with larger, more established competitors, and
SONICblue may be unable to achieve market success. SONICblue's profitability
depends on its ability to successfully implement its new business strategy.

SONICBLUE EXPERIENCED NET OPERATING LOSSES IN THE PAST AND MAY EXPERIENCE NET
OPERATING LOSSES AGAIN IN THE FUTURE.

     SONICblue had net income of $312.8 million for the year ended December 31,
2000, primarily from recognizing a gain on the UMC shares for the first time but
not as a result of income from operations. SONICblue had a net loss of $30.8
million for 1999, and SONICblue's sales during that time consisted of primarily
older generation and lower price products that were sold into markets with
significant price competition. With the completion of the transfer of
SONICblue's graphics chips business, SONICblue's ability to achieve operating
profitability depends on its success in refocusing its business resources and in
executing its business plan for its refocused business. SONICblue cannot assure
you that it will be able to achieve operating profitability. If SONICblue is
unable to achieve operating profitability or incurs future losses and negative
cash flow, its stock price would likely decline.

SONICBLUE DEVELOPS AUDIO PRODUCTS FOR A NEW MARKET, WHICH MAY NOT DEVELOP IF
CONSUMERS DO NOT ACCEPT DIGITAL AUDIO AS THEIR PREFERRED METHOD OF LISTENING TO
MUSIC.

     The market for digital audio products is new and evolving. SONICblue's
digital audio products play music that consumers download from the Internet or
CDs. The success of SONICblue's digital audio products depends in part on
consumers using the Internet, rather than using solely traditional sources, such
as record stores where they buy CDs or cassette tapes, as their preferred source
of music. If consumers do not access music on the Internet, or from their CDs,
and download it for use on SONICblue's products, a market for SONICblue's
products may not develop or may be limited.

A REDUCTION IN THE AVAILABILITY OR EASE OF DOWNLOADING MUSIC FROM THE INTERNET
WILL HURT THE SALES OF SONICBLUE'S PRODUCTS.

     SONICblue's digital audio products play music downloaded from the Internet
and CDs. Currently, litigation is pending that could decrease the availability
of downloadable music available on the Internet. The five major record companies
have sued Napster.com, an Internet service that allows its users to swap songs.
The lawsuits maintain that the swapping of music between different users free of
charge is a violation of the copyright laws in the United States. If the record
companies prevail in the litigation, and Napster or companies offering similar
services are forced to limit the selection of music available for download or
are forced to go out of business, there would be a reduction in the amount of
music available to consumers on the Internet. In March 2001, the court issued an
injunction that orders Napster to police the trading of songs on its web site.

     Some web sites and record companies are working to provide fee-based
downloading of copyright-protected music files. If these web sites are
unsuccessful in providing copyright-protected music files or if consumers find
the downloading too difficult or expensive, acceptance of the Internet as a
source of music would decline. In addition, the rate at which the major record
companies make their music available for digital purchases may discourage the
use of digital audio players or reduce SONICblue's sales. Some record

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companies and Internet companies have announced plans to create CDs or digital
music that cannot be copied or can only be copied a limited number of times,
which would also limit the ability of users to download music from their own CD
collections or share their music with others. New copyright protection measures,
such as these, increased fees associated with making multiple copies of music
from personal collections, or changes in copyright laws, could diminish the
ability of consumers to download music to Rio players. Reductions in the
availability or ease of downloading music from the Internet, or limitations on
copying from personal CDs, could impair the use and sale of SONICblue's digital
audio products.

SONICBLUE HISTORICALLY HAS HAD SIGNIFICANT PRODUCT CONCENTRATION AND CURRENTLY
DEPENDS ON THE HEALTH OF THE DIGITAL AUDIO PLAYER MARKET. THIS MEANS THAT A
DECLINE IN DEMAND FOR A SINGLE PRODUCT, OR IN THE DIGITAL AUDIO PLAYER AND
CONSUMER ELECTRONICS MARKET IN GENERAL, COULD SEVERELY IMPACT SONICBLUE'S
OVERALL REVENUES AND FINANCIAL RESULTS.

     SONICblue's revenues have historically been dependent on the markets for
graphics/video chips for PCs and on its ability to compete in those markets.
With the completion of the transfer of the graphics chips assets to a joint
venture between VIA and a wholly owned subsidiary of SONICblue, SONICblue's
remaining businesses continue to have significant product concentration.
SONICblue is dependent on the markets for digital audio players, modems, home
networking and other consumer electronics products. SONICblue's business would
be materially harmed if it were unsuccessful in selling digital audio players,
including its Rio players. Historically, over 75% of the net sales of
SONICblue's subsidiary, Diamond, have come from sales of graphics and video
accelerator subsystems. Excluding the graphics chips businesses, the Rio players
have historically accounted for over 90% of the remainder of Diamond's sales. In
2000, Rio players and products accounted for 12.2% of SONICblue's net sales. A
decline in demand or average selling prices for digital audio players, modem and
home networking products would have a material adverse effect on SONICblue's
sales and operating results.

BECAUSE SONICBLUE'S LARGEST FINANCIAL ASSET IS ITS SHARES OF UNITED
MICROELECTRONICS CORPORATION, OR UMC, THE VOLATILITY OF SONICBLUE COMMON STOCK
MAY BE INFLUENCED BY THE VOLATILITY OF UMC'S STOCK PRICE.

     SONICblue's largest financial asset is its UMC shares. The market price of
UMC's stock is subject to volatility due to general market conditions as well as
actual or anticipated changes in UMC's business prospects or quarterly or yearly
operating results. The downturn in the semiconductor industry and the economy in
general appears to be more severe than previously anticipated. There is a great
deal of uncertainty regarding when the semiconductor industry will recover from
this down cycle. Because the UMC shares are SONICblue's largest asset, when the
price per share of UMC's stock increases or declines, the price of SONICblue's
common stock on the Nasdaq National Market tends to follow changes in UMC's
stock price. Fluctuations in the price of SONICblue common stock caused by
changes in UMC's stock price may or may not reflect SONICblue's actual or
anticipated business prospects or quarterly results. Also, fluctuations in UMC's
stock price may cause fluctuations in SONICblue's stock price when there is no
material news regarding SONICblue or any change in its results.

THE INFORMATION APPLIANCE MARKET IS NEW AND EVOLVING, AND SONICBLUE'S FRONTPATH
SUBSIDIARY MAY NOT SUCCEED IN DEVELOPING AND BRINGING TO MARKET INFORMATION
APPLIANCES FOR THE HOME AND VERTICAL MARKETS.

     The market for information appliances is new and may not develop as
SONICblue anticipates, if at all. The potential size of this market opportunity
and the timing of its development are uncertain. Broad acceptance of information
appliances will depend on many factors, including the willingness of large
numbers of consumers to use devices other than PCs to access the Internet, and
the development of content and applications that are accessible from information
appliances.

     A number of companies who have attempted to develop and enter the
information appliance market have not succeeded in bringing products to market
or have discontinued them or scaled back their information appliance divisions.
frontpath's new product, the ProGear, has been released in limited quantities
but has not yet been produced or deployed in volume. If frontpath is unable to
obtain manufacturing capacity and develop efficiencies to successfully produce
the ProGear in volume, it will be unable to supply information appliances

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<PAGE>   27

in the vertical markets. frontpath's development of products for the home
depends upon its ability to successfully manufacture and deploy information
appliances in volume. If the market for information appliances does not develop
or develops more slowly than SONICblue anticipates, or if SONICblue fails to
meet the demand of that market or otherwise fails to achieve market penetration
or price stability for its information appliance products, frontpath will
experience losses that will harm SONICblue's operating results.

SALES OF DIGITAL MEDIA AND CONNECTIVITY PRODUCTS DEPEND UPON THE WIDESPREAD
AVAILABILITY AND ADOPTION OF BROADBAND INTERNET ACCESS.

     SONICblue's home networking products and digital audio players, as well as
future consumer-oriented frontpath information appliances, rely or will rely on
high-speed access to the Internet to provide compelling content. Since SONICblue
does not have control over the reliability, availability and quality of
broadband access and related services, it cannot guarantee that broadband access
will be available to all consumers who wish to use information appliances.
Factors that may impede market acceptance of broadband services and products
that rely on high-speed Internet access include:

     - limited geographical service areas and lack of availability of
       cost-effective, high-speed service;

     - inconsistent quality and reliability of broadband service;

     - lack of interoperability among multiple vendors' network equipment;

     - congestion in service providers' networks; and

     - inability to meet demands for increasing bandwidth.

     These factors will likely affect SONICblue's ability to develop a market
for and obtain market acceptance of its products, particularly its information
appliances. frontpath has invested, and is continuing to invest, substantial
resources to develop its information appliances. frontpath would be unable to
generate significant revenues from sales of its information appliances, and will
have expended significant resources on products for which it is generating
limited or no revenues, if broadband access is not available and adopted on a
widespread basis.

SONICBLUE'S BUSINESS IS DEPENDENT ON THE INTERNET AND THE DEVELOPMENT OF THE
INTERNET INFRASTRUCTURE.

     The acceptance and sale of SONICblue's products could decrease if the
infrastructure of the Internet does not continue to be developed and maintained.
For example, if consumers do not have the necessary speed and data capacity for
downloading music, rendering the Internet too slow of a method for obtaining
music, consumers may choose not to download music, which will decrease demand
for SONICblue's digital audio products. In addition, SONICblue's success will
depend in large part on increased use of the Internet which in turn can increase
demand for high-speed communications products and the products that benefit from
high-speed connections. SONICblue's success will also depend on businesses and
consumers using the Internet more frequently for applications that use
multimedia content and that require high bandwidth. Recent growth in Internet
use has caused frequent periods of performance degradation. Any perceived
degradation in the performance of the Internet as a whole could undermine the
benefits of SONICblue's connectivity and digital media products, such as
frontpath information appliances and Rio digital audio players. The performance
of SONICblue's products depends on the speed and reliability of the Internet
infrastructure itself. As a result, the emergence and growth of the market for
SONICblue's products will depend on improvements being made to the entire
Internet infrastructure.

THE JOINT VENTURE WITH VIA WILL REQUIRE SONICBLUE TO PAY SPECIFIED LIQUIDATED
DAMAGES IF CERTAIN EVENTS OCCUR, AND EARN-OUT PAYMENTS TO SONICBLUE FROM THE
JOINT VENTURE ARE SUBJECT TO THE JOINT VENTURE MEETING AGGRESSIVE PROFITABILITY
GOALS.

     The investment agreement with VIA provides that, upon occurrence of certain
events, SONICblue will pay liquidated damages, subject to a maximum damages cap.
Despite the cap, liquidated damages payments

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<PAGE>   28

could harm SONICblue's financial condition or results of operations. In
addition, SONICblue will receive earn-out payments only if the new venture meets
aggressive profitability goals specified in the joint venture agreement. There
can be no assurance that the joint venture will be able to meet these
profitability goals.

SONICBLUE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE THE GROWTH AND EXPANSION OF ITS
BUSINESS.

     In the two past years, and particularly following its merger with Diamond,
SONICblue has experienced a significant expansion in the overall level of its
business and the scope of its operations, including manufacturing, research and
development, marketing, technical support, customer service, sales and
logistics. This expansion has resulted in significant challenges, and a need for
substantial investment in, infrastructure, process development and information
systems, including:

     - attracting, integrating and retaining key employees;

     - integration of management information, product data management, internal
       control, accounting, telecommunications and networking systems;

     - establishment of a significant worldwide web and e-commerce presence;

     - consolidation of geographically dispersed manufacturing and distribution
       facilities;

     - coordination of suppliers, rationalization of distribution channels,
       establishment and documentation of business processes and procedures; and

     - integration of various functions and groups of employees.

SONICBLUE MAY NOT SUCCESSFULLY ADDRESS THESE CHALLENGES.

     SONICblue's future operating results will depend in large measure on its
ability to implement operating, manufacturing and financial procedures and
controls, improve communication and coordination among the different operating
functions, integrate functions such as sales, procurement and operations,
strengthen management information and telecommunications systems, and continue
to hire additional qualified personnel in key areas. SONICblue may be unable to
manage these activities and implement these additional procedures, controls and
systems successfully. Any failure to do so could cause SONICblue's short-term
and long-term operating results to suffer.

SONICBLUE'S QUARTERLY AND ANNUAL OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS
CAUSED BY MANY FACTORS, ANY OF WHICH COULD RESULT IN SONICBLUE'S FAILURE TO
ACHIEVE ITS REVENUE OR PROFITABILITY EXPECTATIONS.

     SONICblue's quarterly and annual results of operations have varied
significantly in the past and are likely to continue to vary in the future due
to a number of factors, many of which are beyond SONICblue's control. Any one or
more of the factors listed below or other factors could cause SONICblue to fail
to achieve its revenue or profitability expectations. The failure to meet market
expectations would likely cause a decline in SONICblue's stock price. These
factors include:

     - SONICblue's ability to develop, introduce, produce in volume quantities
       and market successfully new or enhanced products;

     - SONICblue's ability to introduce and market products in accordance with
       market demand and short design cycles;

     - changes in the relative volume of sales of various products with
       sometimes significantly different margins;

     - market acceptance of and changes in demand for SONICblue's products;

     - rapid changes in electronic commerce on which SONICblue or its customers
       may not capitalize or which erode SONICblue's current business base;

     - gains or losses of significant customers, distributors or strategic
       relationships;

     - unpredictable volume and timing of customer orders;

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     - the availability, pricing and timeliness of delivery of components for
       SONICblue's products, including flash memory;

     - substantial disruption in SONICblue's suppliers' operations, either as a
       result of natural disaster, equipment failure or other cause;

     - fluctuations in the availability of manufacturing capacity or
       manufacturing yields and related manufacturing costs;

     - the timing of new technological advances, product announcements or
       introductions by SONICblue or by its competitors;

     - product obsolescence and the management of product transitions and
       inventory;

     - production delays;

     - decreases in the average selling prices of products;

     - rates of return in excess of those forecasted or expected;

     - seasonal fluctuations in sales;

     - general consumer electronics industry conditions, including changes in
       demand and associated effects on inventory and inventory practices; and

     - general economic conditions, including economic conditions in Asia and
       Europe in particular, that could affect the timing of customer orders and
       capital spending and result in order cancellations or rescheduling.

     Some or all of these factors could adversely affect demand for SONICblue's
products and its future operating results.

     Most of SONICblue's operating expenses are relatively fixed in the short
term. SONICblue may be unable to rapidly adjust spending to compensate for any
unexpected sales shortfall, which could harm its quarterly operating results.
Because the lead times of firm orders are typically short in the consumer
products industry, SONICblue does not have the ability to predict future
operating results with any certainty.

     Because of the above factors, you should not rely on period-to-period
comparisons of results of operations as an indication of future performance.

THE DEMAND FOR SONICBLUE'S PRODUCTS HAS HISTORICALLY BEEN WEAKER IN CERTAIN
QUARTERS, WHICH MAKES IT DIFFICULT TO COMPARE OUR QUARTERLY RESULTS.

     Due to industry seasonality, demand for digital audio and other consumer
electronic products is strongest during the fourth quarter of each year and is
generally slower in the period from March through August. This seasonality may
become more pronounced and material in the future to the extent that:

     - a greater proportion of SONICblue's sales consist of sales into the
       retail/mass merchant channel;

     - SONICblue's net revenues become increasingly based on
       entertainment-related products, including products such as its Rio
       digital music players; or

     - to the extent SONICblue expands its European sales, it may experience
       relatively weak demand in the third calendar quarter due to historically
       weak summer sales in Europe.

     In addition, SONICblue generally ships more products in the third month of
each quarter than in either of the first two months of the quarter, with levels
of shipment in the third month being higher towards the end of the month. This
pattern is likely to continue and makes future quarterly operating results less
predictable. Because the consumer products market experiences substantial
seasonal fluctuations, with more sales occurring toward the end of the year,
SONICblue's quarterly results will be difficult to compare.

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THE MARKETS IN WHICH SONICBLUE OPERATES ARE INTENSELY AND INCREASINGLY
COMPETITIVE, AND IF IT IS UNABLE TO COMPETE SUCCESSFULLY, ITS REVENUES COULD
DECLINE.

     The consumer digital media, consumer electronics, Internet appliance and
home networking markets in which SONICblue competes are intensely competitive
and are likely to become more competitive in the future. Because of this
competition, SONICblue faces a constant and increasing risk of losing customers
to its competitors. The competitive environment also creates downward pressure
on prices and requires higher spending to address the competition, both of which
tend to keep gross margins lower. SONICblue believes that the principal
competitive factors for its products are:

     - performance and quality;

     - ability to conform and adapt to, or upgrade for, current and evolving
       industry standards, including audio formats;

     - access to customers and distribution channels;

     - reputation for quality and strength of brand;

     - manufacturing capabilities and cost of manufacturing;

     - price;

     - product support; and

     - ability to bring new products to the market in a timely manner.

     Many of SONICblue's current and potential competitors have substantially
greater financial, technical, manufacturing, marketing, distribution and other
resources. Some of these competitors may also have greater name recognition and
market presence, longer operating histories, greater market power and product
breadth, lower cost structures and larger customer bases. As a result, these
competitors may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements. In addition, some of SONICblue's principal
competitors may have the advantage of producing their own component parts and
therefore benefit from capacity, cost and technical advantages. For example,
Intel makes flash memory, a key component in digital audio players, and has
recently introduced a digital audio player.

     In some markets where SONICblue is a relatively new entrant, such as
modems, home networking, sound cards and consumer electronics, including digital
audio or Internet music players and Internet appliances, it faces dominant
competitors that include Compaq (Internet appliances and digital audio players),
3Com (home networking and modems), Creative Technology under the name Creative
Labs (sound cards, modems and digital audio players), Handspring (personal
digital assistants, or PDAs, and digital audio player add-ons to PDAs), Gateway
(home networking, home network digital audio players and Internet appliances),
Intel (home networking and digital audio players), Motorola (Internet appliances
and handheld consumer electronics), Palm (PDAs), Samsung (digital audio players,
digital audio player mobile telephones and Internet appliances), Sony (consumer
electronic music, digital audio players and a recently announced Internet
appliance) and Thompson Multimedia (digital audio players). Some of SONICblue's
products face a variety of competitive sources. For example, digital audio
players compete against traditional stereos and CD players, and frontpath
information appliances face competition from manufacturers of stand alone
Internet appliances, wireless portable Internet appliances and manufacturers of
PCs. In addition, the markets in which SONICblue competes are expected to become
increasingly competitive as PC products support increasingly more robust
multimedia functions and companies that previously supplied products providing
distinct functions (for example, companies today primarily in the sound, modem,
microprocessor or motherboard markets) emerge as competitors across broader or
more integrated product categories.

SONICBLUE OPERATES IN MARKETS THAT ARE HIGHLY CYCLICAL AND VULNERABLE TO SHARP
DECLINES IN DEMAND AND AVERAGE SELLING PRICES.

     SONICblue operates in the digital media and consumer electronics markets.
These markets have in the past experienced, and may in the future experience,
significant downturns. In the event of a downturn,

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SONICblue would likely experience significantly reduced demand for its products
and may be pressured to reduce average selling prices. Although SONICblue is
changing its focus to concentrate on its Internet-related and digital media
businesses, substantially all of its revenues during 1999 and 2000 were derived
from products sold for use in or with personal computers. In the near term,
SONICblue expects to continue to derive most of its revenues from the sale of
digital audio products, such as the Rio players. Changes in demand in digital
media and consumer electronics markets could be large and sudden. Since
retailers often build inventories during periods of anticipated growth, they may
be left with excess inventories if market growth slows or if they have
incorrectly forecasted product transitions. In these cases, the retailers may
abruptly stop purchasing additional inventory from suppliers like SONICblue
until the excess inventory has been used. This suspension of purchases or any
reduction in demand for SONICblue's products would negatively impact its
revenues and financial results. SONICblue may experience substantial
period-to-period fluctuations in results of operations due to these general
industry conditions.

IF SONICBLUE IS UNABLE TO CONTINUE TO DEVELOP AND MARKET NEW AND ENHANCED
PRODUCTS, ITS AVERAGE SELLING PRICES AND GROSS MARGINS WILL LIKELY DECLINE.

     SONICblue must continue to develop new products in order to maintain
average selling prices and gross margins. As the markets for its products
develop and competition increases, SONICblue anticipates that product life
cycles will shorten and average selling prices will decline. In particular,
average selling prices and, in some cases, gross margins, for each of its
products will decline as products mature. A decline in selling prices may cause
the net sales in a quarter to be lower than those of a preceding quarter or
corresponding quarter in a prior year, even if more units were sold during that
quarter than in the preceding or corresponding quarter of a prior year. To
minimize the effect of declining average selling prices, SONICblue must
successfully identify new product opportunities and develop and bring new
higher-end and higher-margin products to market in time to meet market demand.
The availability of new products is typically restricted in volume early in a
product's life cycle. If customers choose to wait for the new version of a
product instead of purchasing the current version, SONICblue's ability to secure
the manufacture of sufficient volumes of these new products to meet customer
demand will be limited. If this happens, SONICblue's revenues and operating
margins could be harmed.

     Historically, the gross profit margins on the products of Diamond
Multimedia were lower than the margins on SONICblue's products. As a result of
the Diamond merger, SONICblue's average gross margins have been lower than they
were prior to the Diamond merger, thereby decreasing SONICblue's average gross
margins. In addition, because the products remaining in SONICblue's refocused
business include Diamond products such as the Rio players, SONICblue's average
gross margins will likely be lower after the transfer of the graphics chips
assets to the joint venture between VIA and a wholly owned subsidiary of
SONICblue than prior to the transfer.

IF SONICBLUE FAILS TO IDENTIFY NEW PRODUCT OPPORTUNITIES OR DEVELOP AND MARKET
NEW AND ENHANCED PRODUCTS, IT WILL NOT BE ABLE TO COMPETE SUCCESSFULLY.

     The markets for which SONICblue's products are designed are intensely
competitive and are characterized by rapidly changing technology, evolving
industry standards and short product life cycles. For example, the life cycles
of the Rio audio players typically range from 12 to 18 months. If SONICblue
fails to introduce new products successfully within a given time frame,
SONICblue could lose revenues and market share. Further, continued failure to
develop, introduce and market competitive new products that meet customer
demands on time could also damage SONICblue's brand name, reputation and
relationships with its customers and cause longer-term harm to its financial
condition. SONICblue may not successfully enter the various product markets that
it identifies. In addition, the sale of new products may not become significant
or profitable. To succeed in this environment, SONICblue must anticipate the
features and functionality that customers will demand. SONICblue must then
incorporate those features and functionality into products that meet the design,
performance, quality and pricing requirements of the digital media and consumer
electronics markets in which it competes and the timing requirements of retail
selling seasons. SONICblue believes this will require expenditures for research
and development in the future consistent with its historical research and
development expenditures related to its current refocused businesses. SONICblue
has in the past experienced

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delays in completing the development and introduction of new products and may
experience similar delays in the future. In the past, SONICblue's business was
seriously harmed when it developed products that failed to achieve significant
market acceptance and therefore was unable to compete successfully in its
markets. This type of failure could occur again in the future.

SONICBLUE MUST MANAGE PRODUCT TRANSITIONS SUCCESSFULLY IN ORDER TO REMAIN
COMPETITIVE.

     The introduction of a new product or product line is a complex task,
involving significant expenditures in research and development, training,
promotion and channel development, and management of existing product
inventories to reduce the cost associated with returns and slow moving channel
inventory. As new products are introduced, SONICblue attempts to monitor closely
the inventory of products to be replaced, and to phase out their manufacture in
a controlled manner. There can be no assurance that product transitions will be
executed without harming SONICblue's operating results. Failure to develop
products with required features and performance levels or any delay in bringing
a new product to market could significantly reduce SONICblue's revenues and harm
SONICblue's competitive position.

SONICBLUE DEPENDS ON A LIMITED NUMBER OF SUPPLIERS FROM WHOM IT DOES NOT HAVE A
GUARANTEE OF ADEQUATE SUPPLIES, INCREASING THE RISK THAT A LOSS OF OR PROBLEMS
WITH A SINGLE SUPPLIER COULD RESULT IN IMPAIRED MARGINS, REDUCED PRODUCTION
VOLUMES, STRAINED CUSTOMER RELATIONS AND LOSS OF BUSINESS.

     SONICblue obtains several of the components used in its products, including
flash memory for its Rio players and LCD screens and Transmeta chips for its
frontpath information appliances, from single or limited sources. If component
manufacturers do not allocate a sufficient supply of components to meet its
needs or if current suppliers do not provide components of adequate quality or
compatibility, SONICblue may have to obtain these components from distributors
or on the spot market at a higher cost. SONICblue rarely has guaranteed supply
arrangements with its suppliers, and suppliers may not be able to meet its
current or future component requirements. If SONICblue is forced to use
alternative suppliers of components, it may have to alter its product designs to
accommodate these components. Alteration of product designs to use alternative
components could cause significant delays and reduce its production of the
related products. In addition, from time to time SONICblue has experienced
difficulty meeting certain product shipment dates to customers for various
reasons. These reasons include component delivery delays, component shortages
and component quality deficiencies. Delays in the delivery of components,
component shortages and supplier product quality deficiencies will likely
continue to occur in the future. These delays or problems have in the past and
could in the future result in impaired margins, reduced production volumes,
strained customer relations and loss of business. For example, flash memory
components, which are used in SONICblue's Rio digital audio players,
significantly increased in price in September 1999 due in part to supply
interruptions arising from the earthquake in Taiwan. In addition, industry-wide
demand for flash memory components has increased dramatically, causing increases
in price and shortages in supply. These price increases and shortages may have
an adverse impact on SONICblue's gross margin in future periods.

     Also, in an effort to avoid actual or perceived component shortages,
SONICblue may purchase more of certain components than it may otherwise require.
Excess inventory resulting from over-purchases, obsolescence or a decline in the
market value of such inventory could result in inventory write-offs, which would
have a negative effect on SONICblue's financial results as happened in the first
and second quarters of 1998. Although these over-purchases related to the
graphics chips business, they could occur with respect to other products.
Similarly, prior to SONICblue's acquisition of Diamond, Diamond's perception of
component shortages caused Diamond to over-purchase certain components and pay
surcharges for components that subsequently declined in value in the second,
third and fourth quarters of 1998. In addition, SONICblue's inventory sell-offs
or sell-offs by its competitors could trigger channel price protection charges,
further reducing its gross margins and profitability.

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IF A NEW STORAGE MEDIUM BECOMES THE INDUSTRY STANDARD FOR DIGITAL AUDIO AND
SONICBLUE IS UNABLE TO ADAPT ITS PRODUCTS, SONICBLUE MAY NOT BE ABLE TO COMPETE.

     SONICblue's digital audio players currently include flash memory as their
storage medium. If the digital audio industry adopts a new storage medium as the
industry standard instead of flash memory, SONICblue may not be able to adapt
its products to be compatible with the storage medium. Further, even if
SONICblue is able to adapt its products to a new industry standard storage
medium, SONICblue may experience component shortages, particularly if that
storage medium is based on technology that is proprietary in nature or produced
by a limited number of suppliers.

IF SONICBLUE IS UNABLE TO PREDICT MARKET DEMAND FOR ITS INDIVIDUAL PRODUCTS, AND
FOCUS ITS INVENTORIES AND DEVELOPMENT EFFORTS TO MEET MARKET DEMAND, IT COULD
LOSE SALES OPPORTUNITIES AND EXPERIENCE DECLINES IN REVENUES.

     SONICblue offers a variety of products within each product line or
division. In order to arrange for the manufacture of sufficient quantities of
products and avoid excess inventories, SONICblue needs to accurately predict
market demand for each product. For example, if SONICblue predicted that
consumers would purchase the Rio Volt and plans its manufacturing accordingly,
but instead consumer demand is for the Rio 800, SONICblue would have excess
inventory of the Rio Volt and lost sales opportunities for the Rio 800, as well
as lost market share and brand confidence. SONICblue expects that it will become
even more difficult to forecast demand as it introduces and supports multiple
products and product lines and as competition in the market for its products
intensifies. Significant unanticipated fluctuations in demand could cause
problems in SONICblue's operations. SONICblue may not be able to accurately
predict market demand in order to properly allocate its manufacturing and
distribution resources among its products. As a result, SONICblue may experience
declines in its revenues and lose, or fail to gain, market share.

DEMAND FOR SONICBLUE'S DIGITAL AUDIO PRODUCTS MAY DECREASE IF THE SAME
CAPABILITIES PROVIDED BY ITS PRODUCTS BECOME AVAILABLE IN OR AS ADD-ONS TO OTHER
PERSONAL ELECTRONICS PRODUCTS.

     Excluding sales of graphics chips products, a majority of SONICblue's net
sales in 2000 were derived from the sale of digital audio players. There is a
trend within the personal electronics industry for functionality from individual
products to be integrated with other personal electronics products. For example,
Samsung, Fuji, Handspring and others have developed or announced plans to
develop personal electronic products, such as mobile telephones, digital cameras
or PDA plug-ins that integrate digital audio functions. These products could
significantly reduce the demand for SONICblue's products. As a result of these
trends of technology migration and product integration, SONICblue's success
largely depends on its ability to continue to develop products that incorporate
new and rapidly evolving technologies into its products.

     SONICblue must continue to expand the scope of its research and development
efforts to provide the latest in digital audio technology products, which will
require that it hire and retain engineers skilled in these areas and promote
additional coordination among its design and engineering groups. Alternatively,
SONICblue may find it necessary or desirable to license or acquire technology to
enable it to provide these functions. This technology may not be available for
license or purchase on terms acceptable to SONICblue, if at all.

SONICBLUE DEPENDS ON THIRD PARTIES FOR THE MANUFACTURE OF ITS PRODUCTS.

     SONICblue relies on independent subcontractors to manufacture, assemble
and/or test its products. SONICblue procures its components, assembly and test
services and assembled products through purchase orders, and it does not have
specific volume purchase agreements with each of its subcontractors. Most of its
subcontractors could cease supplying the services, products or components at any
time with limited or no penalty. If SONICblue needs to replace a key
subcontractor, it could incur significant manufacturing set-up costs and delays.
Also, SONICblue may be unable to find suitable replacement subcontractors.
SONICblue's emphasis on maintaining low internal and channel inventory levels
may exacerbate the effects of any shortage that may result from the use of
sole-source subcontractors during periods of tight supply or rapid order growth.
Further, some of SONICblue's subcontractors are located outside the United
States, which may present

                                        31
<PAGE>   34

heightened process control, quality control, political, infrastructure,
transportation, tariff, regulatory, legal, import, export, economic or supply
chain management risks.

     SONICblue faces competition for access to manufacturers and manufacturing
capacity. Many of the companies competing with SONICblue for this capacity have
longer operating histories and greater financial and market resources than
SONICblue. SONICblue may not be able to maintain access to adequate capacity of
high quality manufacturing if its subcontractors choose to offer their services
to other companies who can negotiate better terms due to their market presence,
pay higher prices, engage more manufacturing capacity or offer other incentives.
As SONICblue develops new products, such as its frontpath information
appliances, it will require manufacturing capacity to produce quantities to meet
market demand. If SONICblue is unable to obtain and maintain access to high
quality manufacturing capacity for its existing and future products, it will not
be able to fill distributor or customer orders, and its revenues will decline.

SONICBLUE'S PRODUCTS COULD HAVE DEFECTS OR COMPATIBILITY ISSUES, WHICH COULD BE
COSTLY TO CORRECT AND COULD RESULT IN THE REJECTION OF ITS PRODUCTS AND DAMAGE
TO ITS REPUTATION, AS WELL AS LOST REVENUES, DIVERTED DEVELOPMENT RESOURCES AND
INCREASED SERVICE COSTS AND WARRANTY CLAIMS.

     SONICblue's products could have design defects that could cause them to
malfunction. Product components may contain undetected errors or "bugs" when
first supplied to SONICblue that, despite testing by SONICblue, are discovered
only after SONICblue's products have been installed and used by customers. From
time to time, SONICblue has become aware of problems with components, product
designs and other defects. Errors or defects in SONICblue's products may arise
in the future, and, if significant or perceived to be significant, could result
in rejection of SONICblue's products, product returns or recalls, damage to
SONICblue's reputation, lost revenues, diverted development resources and
increased customer service and support costs and warranty claims. Errors or
defects in SONICblue's products could also result in product liability claims.

     SONICblue includes, or bundles, third party software, including operating
systems, with its hardware products. For example, SONICblue includes software
with its Rio players that the purchaser may use to download and store MP3 or WMA
files on the player. SONICblue also incorporates third party software in its
frontpath information appliances. The software products and SONICblue's hardware
products are complex and may contain undetected errors or failures when first
introduced or as new versions are released. SONICblue has distributed updates to
Rio players in the past when required to improve sound quality or to correct
minor audio problems. SONICblue generally provides warranties for its retail
products allowing the return or repair of defective products. Despite testing by
SONICblue, its suppliers or current or potential customers, errors may be found
in new products after commencement of commercial shipments. These errors could
result in loss of or delay in market acceptance or product acceptance or in
warranty returns. Losses, delays or damage to SONICblue's reputation due to
product defects would likely harm SONICblue's business, financial condition and
results of operations.

     Additionally, new versions or upgrades to operating systems, independent
software vendor titles or applications may require upgrades to the software
products SONICblue bundles with its hardware products, or the software products
that purchasers of SONICblue's products may obtain from other sources such as
the Internet, to maintain compatibility with the new versions or upgrades. The
sources for the software SONICblue bundles, or the other sources for purchasers
of SONICblue's products to obtain software, may not be successful in developing
new versions, upgrades or enhancements to their software products. If producers
of software experience delays or are unable to maintain compatibility with new
audio formats, operating systems and independent software vendor titles or
applications, the demand for SONICblue's products and SONICblue's reputation
could suffer. Loss of sales and damaged reputation could harm SONICblue's
revenues and profitability.

                                        32
<PAGE>   35

SONICBLUE IS SUBJECT TO RISKS RELATING TO PRODUCT RETURNS AND PRICE PROTECTION,
WHICH COULD LIMIT SONICBLUE'S REVENUES.

     SONICblue often grants limited rights to customers and distributors to
return unsold inventories of its products in exchange for new products, also
known as "stock rotation." SONICblue also often grants price protection on
unsold inventory, which allows customers to receive a price adjustment on
existing inventory when its published price is reduced. Also, some of
SONICblue's retail customers may accept returned products from their own retail
customers. These products are then returned to SONICblue for credit. SONICblue
has experienced a significant percentage returns of its Rio players. SONICblue
estimates returns and potential price protection on unsold inventory in its
distribution channel and accrues reserves for estimated returns, including
warranty returns and price protection. Since the fourth quarter of 1998, it
reserves the gross margin associated with channel inventory levels that exceed
four weeks of demand. SONICblue may be faced with further significant price
protection charges as its customers move to reduce channel inventory levels of
current products, such as its Rio 500, as new product introductions are made.

     In an environment of slower demand and abundant supply of products, price
declines and channel promotional expenses are more likely to occur and, should
they occur, are more likely to have a significant impact on SONICblue's
operating results. Further, in this environment, high channel inventory levels
may result in substantial price protection charges. These price protection
charges have the effect of reducing net sales and gross margin. Consequently, in
taking steps to bring its channel inventory levels down to a more desirable
level, SONICblue may cause a shortfall in net sales during one or more
accounting periods. These efforts to reduce channel inventory might also result
in price protection charges if prices are decreased to move product out to final
consumers, having a further adverse impact on operating results. Any estimates,
reserves or accruals may be insufficient and any future price reductions may
seriously harm its operating results.

SONICBLUE DEPENDS ON SALES THROUGH DISTRIBUTORS. IF RELATIONSHIPS WITH OR SALES
THROUGH DISTRIBUTORS DECLINE, ITS OPERATING RESULTS WILL BE HARMED.

     SONICblue sells its products through a network of domestic and
international distributors, and directly to major retailers/mass merchants.
SONICblue's future success is dependent on the continued viability and financial
stability of its customer base. Retail channels historically have been
characterized by rapid change, including periods of widespread financial
difficulties and consolidation and the emergence of alternative sales channels,
such as direct mail order, telephone sales and electronic commerce on the
worldwide web. SONICblue may be unable to retain its distributors. Also, its
distributors may cancel or reschedule orders, and in the event of canceled
orders, these orders may not be replaced by other sales. In addition, sales to
any particular distributor may fluctuate significantly from quarter to quarter.
The loss of, or a reduction in, sales to any of SONICblue's key distribution
customers as a result of changing market conditions, competition or customer
credit problems could materially and adversely affect its operating results.
Likewise, changes in distribution channel patterns, such as increased electronic
commerce via the Internet and increased use of mail-order catalogues, could
affect SONICblue in ways not yet known. For example, the rapid emergence of
Internet-based e-commerce, in which products are sold directly to consumers at
low prices, is putting substantial strain on some of SONICblue's traditional
distribution channels.

     Inventory levels of SONICblue's products in the two-tier distribution
channels generally are maintained in a range of one to two months of customer
demand. These channel inventory levels tend toward the low end of the
months-of-supply range when demand is stronger, sales are higher and products
are in short supply. Conversely, during periods when demand is slower, sales are
lower and products are abundant, channel inventory levels tend toward the high
end of the months-of-supply range. Frequently, in these situations, SONICblue
attempts to ensure that distributors devote a greater degree of their working
capital, sales and logistics resources to SONICblue's products instead of to the
products of SONICblue's competitors. Similarly, SONICblue's competitors attempt
to ensure that their own products are receiving a disproportionately higher
share of the distributors' working capital and logistics resources. SONICblue
may experience significant decreases in revenues if its competitors are able to
secure more resources than SONICblue is able to secure from distributors during
periods of slower demand or if periods of slower demand result in price
protection charges.

                                        33
<PAGE>   36

SONICBLUE'S ABILITY TO MARKET AND DISTRIBUTE ITS PRODUCTS DEPENDS IN PART UPON
ITS CURRENT AND FUTURE RELATIONSHIPS WITH ORIGINAL EQUIPMENT MANUFACTURERS, OR
OEMS, AND OTHER STRATEGIC PARTNERS TO MARKET AND DISTRIBUTE SONICBLUE'S PRODUCTS
UNDER THEIR OWN BRAND NAMES.

     In addition to direct distributors of SONICblue's products, SONICblue also
depends upon OEMs and other strategic partners to market and distribute its
products. For example, SONICblue has packaged for Dell a digital audio receiver
that streams digital audio from a home computer to the receiver, and through a
strategic partnership with Nike, SONICblue has developed a digital audio player
that is designed for fitness enthusiasts. If SONICblue is unable to obtain and
maintain relationships with OEMs and strategic partners, it will not be able to
increase sales of its products and achieve market acceptance as efficiently, and
its revenues may decline.

SONICBLUE RELIES ON INTELLECTUAL PROPERTY AND OTHER PROPRIETARY INFORMATION THAT
MAY NOT BE ADEQUATELY PROTECTED AND THAT MAY BE EXPENSIVE TO PROTECT.

     The markets in which SONICblue competes are characterized by vigorous
protection and pursuit of intellectual property rights. SONICblue relies on a
combination of patent, trademark, copyright, and trade secret laws, employee and
third-party nondisclosure agreements and licensing arrangements to protect its
intellectual property. If SONICblue is unable to adequately protect its
intellectual property, its business may suffer from the piracy of its technology
and the associated loss of sales. Also, the protection provided to SONICblue's
proprietary technology by the laws of foreign jurisdictions, many of which offer
less protection than the United States, may not be sufficient to protect its
technology. It is common in the personal electronics and Internet device
industries for companies to assert intellectual property infringement claims
against other companies. Therefore, SONICblue's products may also become the
target of infringement claims. These infringement claims or any future claims
could cause SONICblue to spend significant time and money to defend its
products, redesign its products or develop or license a substitute technology.
SONICblue may be unsuccessful in acquiring or developing substitute technology
and any required license may be unavailable on commercially reasonable terms, if
at all. In addition, an adverse result in litigation could require SONICblue to
pay substantial damages, cease the manufacture, use, sale, offer for sale and
importation of infringing products, or discontinue the use of certain processes.
Any of these events could materially harm SONICblue's business.

     Litigation by or against SONICblue could result in significant expense and
could divert the efforts of its technical and management personnel, regardless
of the outcome of such litigation. However, even if claims do not have merit,
SONICblue may be required to dedicate significant management time and expense to
defending itself if it is directly sued, or assisting its customers in their
defense of these or other infringement claims pursuant to indemnity agreements.
This could have a negative effect on SONICblue's financial results.

SONICBLUE MAY NOT BE ABLE TO ATTRACT, RETAIN OR INTEGRATE KEY PERSONNEL, WHICH
MAY PREVENT IT FROM SUCCEEDING.

     SONICblue may not be able to retain its key personnel or attract other
qualified personnel in the future. SONICblue's success will depend upon the
continued service of key management personnel. The loss of services of any of
the key members of SONICblue's management team or its failure to attract and
retain other key personnel could disrupt operations and have a negative effect
on employee productivity and morale, decreasing production and harming its
financial results. In addition, the competition to attract, retain and motivate
qualified technical personnel, such as engineers, as well as qualified sales and
operations personnel, is intense. SONICblue has at times experienced, and
continues to experience, difficulty recruiting qualified software and hardware
development engineers.

SONICBLUE DEPENDS ON A LIMITED NUMBER OF THIRD PARTY DEVELOPERS AND PUBLISHERS
THAT DEVELOP SOFTWARE PRODUCTS THAT WILL OPERATE WITH AND FULLY UTILIZE THE
CAPABILITIES OF ITS RIO PLAYERS.

     Only a limited number of software developers are producing software that
enables the download and use of digital audio players. SONICblue does not create
the software that is required to download or convert from

                                        34
<PAGE>   37

CDs music to run on its players but bundles third party software with its
players. If SONICblue is not able to license and bundle the software, or if
users are not otherwise able to obtain software free of charge or at an
acceptable price, then demand for SONICblue's digital audio players will
decline. Likewise, difficult to use or defective software could negatively
impact SONICblue's product sales and revenues.

SONICBLUE HAS SIGNIFICANT EXPOSURE TO INTERNATIONAL MARKETS.

     Export sales accounted for 56%, 70% and 89% of net sales in 2000, 1999 and
1998, respectively. Approximately 33% of export sales in 2000 were to affiliates
of United States customers. In addition, a substantial proportion of SONICblue's
products are manufactured, assembled and tested by independent third parties in
Asia. As a result, SONICblue is subject to the risks of conducting business
internationally, including:

     - unexpected changes in, or impositions of, legislative or regulatory
       requirements;

     - fluctuations in the U.S. dollar, which could increase the price in local
       currencies of SONICblue's products in foreign markets or increase the
       cost of wafers and components purchased by SONICblue;

     - delays resulting from difficulty in obtaining export licenses for certain
       technology;

     - tariffs and other trade barriers and restrictions;

     - potentially longer payment cycles;

     - greater difficulty in accounts receivable collection;

     - potentially adverse tax treatment; and

     - the burdens of complying with a variety of foreign laws.

     In the past, SONICblue has experienced an adverse impact associated with
the economic downturn in Asia that contributed to decreases in net sales. In
addition, SONICblue's international operations are subject to general
geopolitical risks, such as political and economic instability and changes in
diplomatic and trade relationships. The People's Republic of China and Taiwan
have in the past experienced and are currently experiencing strained relations,
and a worsening of relations or the development of hostilities between them
could disrupt operations at the manufacturing facilities of SONICblue's
subcontractors and affect its Asian customers.

SONICBLUE HAS A SIGNIFICANT LEVEL OF DEBT, WHICH MAY HARM ITS ABILITY TO OBTAIN
ADDITIONAL FINANCING OR ADVERSELY AFFECT ITS LIQUIDITY.

     At December 31, 2000, SONICblue had total debt and other long-term
liabilities outstanding of $107 million, including a $70 million line of credit
secured by SONICblue's shares of UMC. Foreclosure on the UMC shares would harm
SONICblue's financial condition. The degree to which SONICblue is leveraged
could harm its ability to obtain additional financing for working capital or
other purposes and could make SONICblue more vulnerable to economic downturns
and competitive pressures. SONICblue's significant leverage could also adversely
affect its liquidity, as a substantial portion of available cash from operations
may have to be applied to meet debt service requirements. In the event of a cash
shortfall, SONICblue could be forced to reduce other expenditures to be able to
meet such debt service requirements.

MINORITY INVESTMENTS COULD ADVERSELY AFFECT SONICBLUE'S LIQUIDITY AND EARNINGS.

     SONICblue holds minority interests in companies having operations or
technology in areas within its strategic focus. Some of these investments are in
research and development, start-up or development stage companies or companies
where operations are not yet sufficient to establish them as going concerns. As
a result, SONICblue may be called upon under contractual or other terms to
provide funding for operations of these companies and may share in their losses.
Adverse changes in market conditions or poor operating results of underlying
investments could result in SONICblue incurring losses or an inability to
recover the carrying value of its investments.

                                        35
<PAGE>   38

SONICBLUE MAY PURSUE STRATEGIC ACQUISITIONS AND COULD FAIL TO SUCCESSFULLY
INTEGRATE ACQUIRED BUSINESSES.

     SONICblue has engaged in acquisitions in the past, has recently announced
proposed acquisitions of Sensory Science and ReplayTV, and expects to evaluate
acquisition opportunities in the future that could provide additional product or
services offerings, technologies or additional industry expertise. Any proposed
or future acquisition could result in difficulties assimilating acquired
operations and products, diversion of capital and management's attention away
from other business issues and opportunities and amortization of acquired
intangible assets. Integration of acquired companies may result in problems
related to integration of technology and management teams. SONICblue could fail
to integrate the operations, personnel or products that it may acquire in the
future. If SONICblue fails to successfully integrate acquisitions or achieve any
anticipated benefits of an acquisition, its operations and business could be
harmed.

SONICBLUE IS A PARTY TO LEGAL PROCEEDINGS ALLEGING SECURITIES VIOLATIONS THAT
COULD HAVE A NEGATIVE FINANCIAL IMPACT ON US.

     Since November 1997, a number of complaints have been filed in federal and
state courts seeking unspecified damages on behalf of an alleged class of
persons who purchased shares of SONICblue's common stock at various times
between April 18, 1996 and November 3, 1997. The complaints name as defendants
SONICblue, certain of its officers and former officers, and certain directors of
SONICblue, asserting that they violated federal and state securities laws by
misrepresenting and failing to disclose certain information about SONICblue's
business. In addition, certain stockholders have filed derivative actions in the
state courts of California and Delaware seeking recovery on behalf of SONICblue,
alleging, among other things, breach of fiduciary duties by such individual
defendants. The plaintiffs in the derivative action in Delaware have not taken
any steps to pursue their case. The derivative cases in California State court
have been consolidated, and plaintiffs have filed a consolidated amended
complaint. The court has entered a stipulated order in those derivative cases
suspending court proceedings and coordinating discovery in them with discovery
in the class actions in California State courts. On plaintiffs' motion, the
federal court has dismissed the federal class actions without prejudice. The
class actions in California State court have been consolidated, and plaintiffs
have filed a consolidated amended complaint. SONICblue has answered that
complaint. Discovery is proceeding. On January 22, 2001, four of the insurance
carriers which issued directors and officers insurance to SONICblue filed suit
against all parties named as defendants in the securities litigation, claiming
that the carriers have no obligation to provide coverage under the California
Insurance Code. While management intends to defend the actions against SONICblue
vigorously, there can be no assurance that an adverse result or settlement with
regard to these lawsuits would not have a material adverse effect on SONICblue's
financial condition or results of operations.

     SONICblue has received from the Securities and Exchange Commission a
request for information relating to SONICblue's restatement announcement in
November 1997. SONICblue has responded and intends to continue to respond to
such requests.

     SONICblue has also been defending several putative class action lawsuits
naming Diamond, which were filed in June and July 1996 and June 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain former executive officers and
directors of Diamond are also named as defendants. The plaintiffs purport to
represent a class of all persons who purchased Diamond's common stock between
October 18, 1995 and June 20, 1996, or the Class Period. The complaints allege
claims under the federal securities laws and California law. The plaintiffs
allege that Diamond and the other defendants made various material
misrepresentations and omissions during the Class Period. The complaints do not
specify the amount of damages sought. On March 24, 2000, the District Court for
the Northern District of California dismissed the federal action without
prejudice. The parties have tentatively agreed to settle this matter, subject to
final documentation and court approval, for a payment of $15.0 million.
SONICblue funded $4.5 million of the settlement on November 1, 2000. SONICblue
previously accrued this amount in connection with the merger with Diamond.
SONICblue believes that Diamond's insurance covers the remaining $10.5 million
of the settlement and Diamond's insurers have funded that amount into the
settlement.

                                        36
<PAGE>   39

     Sega Corporation initiated a claim for arbitration in Tokyo, Japan against
Diamond in December 1998. The claim arises out of an agreement entered into
between Sega and Diamond in September 1995, in which Sega agreed to provide
Diamond with Sega game software that Diamond would bundle with its 3-D graphics
board "The Edge." Sega claims that Diamond breached the parties' agreement by
failing to pay Sega a contractual minimum royalty fee for the games as set forth
in the agreement. Sega claims as damages $3.8 million in unpaid royalties and
pre-judgment interest. On May 28, 1999, Diamond responded to Sega's claims by
filing an answer in which it denied the material allegations of Sega's claims.
The parties have filed additional briefs in support of their claims and
defenses. An evidentiary hearing on this action has not yet been scheduled.
SONICblue contests the material allegations of Sega's claims. In addition,
SONICblue has pleaded that Sega's failure to provide it with 3-D optimized game
software on a timely basis adversely affected sales of The Edge. SONICblue
claims that these lost sales and profits should provide an offset to Sega's
claims in the arbitration and intends to defend the suit vigorously.

     C3 Sales, Inc. filed suit against SONICblue on October 6, 1999 in the
Harris County (Houston), Texas District Court. The petition sought a judicial
declaration that a Sales Representative Agreement entered into between C3 and
SONICblue on May 19, 1999 was a valid contract that governed the relationship
between the two parties. On November 8, 1999, SONICblue answered acknowledging
that the May 19, 1999 agreement was a contract between the two parties. C3
failed to respond to informal requests by SONICblue to dismiss the declaratory
relief action on grounds that no justiciable controversy existed between the
parties. On December 3, 1999, SONICblue filed a summary judgment motion seeking
judgment against C3 on the grounds that no issues of material fact remain to be
determined regarding the declaratory judgment sought by C3. C3 responded by
filing an amended petition raising new matters. Specifically, C3's new claims
allege that the Sales Representative Agreement applies to Diamond products, and
that certain commissions due under the agreement have not been paid. SONICblue
intends to defend this action vigorously.

     On January 6, 2000, PhoneTel Communications, Inc. filed a complaint for
patent infringement against a group of defendants, including Diamond, in the
United States District Court for the Northern District of Texas. PhoneTel
generally alleges that Diamond and the other defendants are infringing its two
patents by making, using, selling, offering to sell and/or importing digital
synthesizers, personal computers, sound cards, or console game systems. PhoneTel
does not specify which Diamond products allegedly infringe its patents.
SONICblue filed Diamond's answer to the complaint on March 28, 2000. SONICblue
believes it has meritorious defenses and intends to vigorously defend itself
against the allegations made in the complaint.

                                        37
<PAGE>   40

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

INVESTMENT PORTFOLIO

     The Company does not use derivative financial instruments in its investment
portfolio. The Company invests in instruments that meet high credit quality
standards, as specified in the Company's investment policy. The Company also
limits the amount of credit exposure to any one issue, issuer or type of
investment.

     The table below summarizes the Company's investment cash and equivalents
and its short-term investments (all short-term investments are classified as
available for sale).

<TABLE>
<CAPTION>
                                                                   FAIR VALUE
                                                             ----------------------
                                                                 (IN THOUSANDS,
                                                             EXCEPT INTEREST RATES)
<S>                                                          <C>
At December 31, 2000:
Cash and equivalents.......................................         $ 36,582
Weighted average interest rate.............................            5.33%
Short-term investments.....................................         $  9,017
Weighted average interest rate.............................            5.52%
Total portfolio............................................         $ 45,599
Weighted average interest rate.............................            5.37%

At December 31, 1999:
Cash and equivalents.......................................         $ 45,825
Weighted average interest rate.............................            4.94%
Short-term investments.....................................         $ 58,918
Weighted average interest rate.............................            6.48%
Total portfolio............................................         $104,743
Weighted average interest rate.............................            5.81%
</TABLE>

     A hypothetical 10% change in market interest rates would not have a
material effect on the Company's operations, cash flows, or the value of its
short-term investments.

     The Company also holds an investment in UMC, a publicly traded company,
which was carried at $635.0 million on the Company's consolidated balance sheet
at December 31, 2000. This investment is subject to market risk. At December 31,
2000, the market value of both our short-term and long-term investment in UMC
had declined to $407.2 million. A 10% decline in the market value of the UMC
stock would reduce the market value of the number of shares we held at December
31, 2000 by approximately $40.7 million. It was determined that the decline from
the carrying value at December 31, 2000 and the original cost basis was related
to the downturn in the semiconductor industry as a whole and was temporary in
nature due to the historically cyclical nature of the industry. Subsequent to
the year end, the market value of the investment in UMC remained significantly
below cost. The downturn in the semiconductor industry and the economy in
general appears to be more severe than previously anticipated. There is a great
deal of uncertainty regarding when the semiconductor industry will recover from
this down cycle. Should the Company conclude that the decline in value is other
than temporary, they will report a loss in other income and expense at that
time.

CONVERTIBLE SUBORDINATED NOTES

     In September 1996, the Company completed a private placement of $103.5
million aggregate principal amount of convertible subordinated notes. The notes
mature in 2003. Interest is payable semi-annually at 5 3/4% per annum. The notes
are convertible at the option of the note holders into the Company's common
stock at an initial conversion price of $19.22 per share, subject to adjustment.
During 2000, $0.2 million in notes were converted into common stock. Beginning
in October 1999, the notes became redeemable at the option of the Company at an
initial redemption price of 102% of the principal amount. The fair value of the
convertible subordinated notes at December 31, 2000 and 1999 was approximately
$70.92 million and $96.13 million,

                                        38
<PAGE>   41

respectively. A hypothetical 10% change in market interest rates would not have
a material adverse effect on the Company's operations, cash flows or the fair
value of the convertible subordinated notes.

IMPACT OF FOREIGN CURRENCY RATE CHANGES

     The Company invoices its customers in U.S. dollars for all products. The
Company is exposed to foreign exchange rate fluctuations as the financial
results of its foreign subsidiaries are translated into U.S. dollars in
consolidation. The foreign subsidiaries maintain their accounts in the local
currency of the foreign location in order to centralize the foreign exchange
risk with the Company.

     The effect of foreign exchange rate fluctuations on the Company's financial
statements for the years ended December 31, 2000 and 1999 was not material. From
time to time the Company uses foreign exchange contracts as a means for hedging
assets or liabilities denominated in foreign currencies. As of December 31,
2000, the Company held no exchange contracts. As of December 31, 1999, the
Company had the following foreign exchange contracts:

<TABLE>
<CAPTION>
                                                           MATURITY DATE    NOTIONAL    FAIR VALUE
                                                           -------------    --------    ----------
                                                                                (IN THOUSANDS)
<S>                                                        <C>              <C>         <C>
Foreign Currency Forward Exchange Contracts:
  275,905,000 New Taiwan Dollars.........................  April 3, 2000     $8,489       $(200)
  275,905,000 New Taiwan Dollars.........................   July 5, 2000     $8,466       $(186)
</TABLE>

                                        39
<PAGE>   42

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

      INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF SONICBLUE INCORPORATED

<TABLE>
<CAPTION>
                                                              PAGE(S)
                                                              -------
<S>                                                           <C>
Report of Ernst & Young LLP, Independent Auditors...........    41
Consolidated Statements of Operations for the years ended
  December 31, 2000, 1999, and 1998.........................    42
Consolidated Balance Sheets as of December 31, 2000 and
  1999......................................................    43
Consolidated Statements of Stockholders' Equity for the
  years ended December 31, 2000, 1999 and 1998..............    44
Consolidated Statements of Cash Flows for the years ended
  December 31, 2000, 1999 and 1998..........................    45
Notes to Consolidated Financial Statements..................    46
Selected Quarterly Consolidated Financial Data
  (Unaudited)...............................................    67
</TABLE>

                                        40
<PAGE>   43

               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

Stockholders and Board of Directors
SONICblue Incorporated

     We have audited the accompanying consolidated balance sheets of SONICblue
Incorporated and its subsidiaries as of December 31, 2000 and 1999, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2000. Our
audits also included the financial statement schedule listed in the index at
item 14(a)(2). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.

     We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of SONICblue
Incorporated and subsidiaries at December 31, 2000 and 1999, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.

San Jose, California
February 1, 2001,
except for the last three paragraphs
in Note 17, as to which the date is
March 30, 2001

                                        41
<PAGE>   44

                             SONICBLUE INCORPORATED

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31,
                                                          -----------------------------------
                                                            2000         1999         1998
                                                          ---------    ---------    ---------
<S>                                                       <C>          <C>          <C>
Net sales...............................................  $ 536,704    $ 352,583    $ 224,639
Cost of sales...........................................    548,616      307,161      226,711
                                                          ---------    ---------    ---------
Gross margin (loss).....................................    (11,912)      45,422       (2,072)
Operating expenses:
  Research and development..............................     83,433       73,896       78,566
  Selling, marketing and administrative.................    126,852       52,832       41,926
  Restructuring expense.................................      6,694           --        6,109
  Other operating expense...............................         --        6,700       35,226
  Amortization of goodwill and intangibles..............     44,440       12,156           --
                                                          ---------    ---------    ---------
          Total operating expenses......................    261,419      145,584      161,827
                                                          ---------    ---------    ---------
Loss from operations....................................   (273,331)    (100,162)    (163,899)
  Gain on sale of manufacturing joint venture...........     14,738       22,433       26,561
  Gain on UMC investment, net...........................    869,401           --           --
  Gain on sale of other investments.....................      5,917           --           --
  Equity income (loss) of investees.....................    (11,373)         (54)      17,469
  Interest expense......................................     (9,181)      (7,205)      (6,235)
  Other income (expense), net...........................     (1,865)       6,292          944
                                                          ---------    ---------    ---------
Income (loss) before income taxes.......................    594,306      (78,696)    (125,160)
Income tax expense (benefit)............................    281,478      (47,916)     (11,956)
                                                          ---------    ---------    ---------
Net income (loss).......................................  $ 312,828    $ (30,780)   $(113,204)
                                                          =========    =========    =========
Earnings per share amounts:
  Basic.................................................  $    3.46    $   (0.52)   $   (2.22)
  Diluted...............................................  $    3.13    $   (0.52)   $   (2.22)
Shares used in computing per share amounts:
  Basic.................................................     90,390       59,244       51,078
  Diluted...............................................    101,150       59,244       51,078
</TABLE>

          See accompanying notes to consolidated financial statements.
                                        42
<PAGE>   45

                             SONICBLUE INCORPORATED

                          CONSOLIDATED BALANCE SHEETS
                (IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)

                                     ASSETS

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                              ----------------------
                                                                 2000         1999
                                                              ----------    --------
<S>                                                           <C>           <C>
Current assets:
  Cash and equivalents......................................  $   36,582    $ 45,825
  Investment -- UMC.........................................     228,673          --
  Short-term investments....................................       9,017      58,918
  Accounts receivable (net of allowances of $7,790 in 2000
     and $19,298 in 1999)...................................      85,950      78,312
  Inventories...............................................      86,727      97,161
  Deferred income taxes.....................................          --      19,658
  Prepaid expenses and other................................       9,734      24,779
                                                              ----------    --------
          Total current assets..............................     456,683     324,653
  Property and equipment -- net.............................      24,761      34,404
  Investment -- UMC.........................................     406,363          --
  Investments -- Other......................................          --      92,763
  Deferred income taxes.....................................          --      56,458
  Goodwill and intangible assets............................     162,381     199,139
  Other assets..............................................      49,117      15,230
                                                              ----------    --------
          Total.............................................  $1,099,305    $722,647
                                                              ==========    ========
                        LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................  $   99,296    $117,539
  Notes payable.............................................      72,672      51,261
  Accrued compensation and benefits.........................      11,260       9,167
  Accrued liabilities.......................................      28,613      30,803
  Income taxes payable......................................       5,481       5,781
  Deferred income taxes.....................................      69,563          --
  Deferred revenue..........................................       8,287       9,953
                                                              ----------    --------
          Total current liabilities.........................     295,172     224,504
Deferred income taxes.......................................      25,140          --
Other liabilities...........................................       4,040      12,010
Convertible subordinated notes..............................     103,300     103,500
Commitments and contingencies (Notes 7 and 12) Stockholders'
  equity:
  Preferred stock, $.0001 par value; 5,000,000 shares
     authorized; none outstanding...........................          --          --
  Common stock, $.0001 par value; 175,000,000 shares
     authorized; 93,054,332 and 78,139,745 shares
     outstanding in 2000 and 1999, respectively.............           9           8
  Additional paid-in capital................................     602,557     434,330
  Accumulated other comprehensive loss......................    (199,599)     (7,563)
  Retained earnings (accumulated deficit)...................     268,686     (44,142)
                                                              ----------    --------
          Total stockholders' equity........................     671,653     382,633
                                                              ----------    --------
          Total.............................................  $1,099,305    $722,647
                                                              ==========    ========
</TABLE>

          See accompanying notes to consolidated financial statements.
                                        43
<PAGE>   46

                             SONICBLUE INCORPORATED

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                         (IN THOUSANDS, EXCEPT SHARES)

<TABLE>
<CAPTION>
                                                                                       ACCUMULATED
                                                                                          OTHER         RETAINED
                                                      COMMON STOCK       ADDITIONAL   COMPREHENSIVE     EARNINGS
                                                   -------------------    PAID-IN        INCOME       (ACCUMULATED
                                                     SHARES     AMOUNT    CAPITAL        (LOSS)         DEFICIT)       TOTAL
                                                   ----------   ------   ----------   -------------   ------------   ---------
<S>                                                <C>          <C>      <C>          <C>             <C>            <C>
BALANCE AT DECEMBER 31, 1997.....................  50,549,279     $5      $187,271      $ (16,278)     $  99,842     $ 270,840
  Comprehensive loss
    Net loss.....................................          --     --            --             --       (113,204)     (113,204)
    Other comprehensive income, net of tax:
      Change in unrealized loss on investments...          --     --            --         (5,995)            --        (5,995)
      Change in foreign currency translation
        adjustment...............................          --     --            --          7,518             --         7,518
                                                                                                                     ---------
    Other comprehensive income...................                                                                        1,523
                                                                                                                     ---------
  Comprehensive loss.............................                                                                     (111,681)
    Exercise of stock options....................     560,546     --         1,984             --             --         1,984
    Employee stock purchase plan.................     606,346     --         2,387             --             --         2,387
                                                   ----------     --      --------      ---------      ---------     ---------
BALANCE AT DECEMBER 31, 1998.....................  51,716,171      5       191,642        (14,755)       (13,362)      163,530
  Comprehensive loss
    Net loss.....................................          --     --            --             --        (30,780)      (30,780)
    Other comprehensive income, net of tax:
      Change in unrealized loss on investments...          --     --            --          3,132             --         3,132
      Change in foreign currency translation
        adjustment...............................          --     --            --          4,060             --         4,060
                                                                                                                     ---------
    Other comprehensive income...................                                                                        7,192
                                                                                                                     ---------
  Comprehensive loss.............................          --     --            --             --             --       (23,588)
  Private issuance...............................   3,423,000      1        34,438             --             --        34,439
  Exercise of stock options......................   3,390,645     --        18,155             --             --        18,155
  Employee stock purchase plan...................     895,491     --         2,294             --             --         2,294
  Diamond acquisition............................  18,714,438      2       183,923             --             --       183,925
  Sale of warrant................................          --     --           990             --             --           990
  Tax benefit of stock option transactions.......          --     --         2,888             --             --         2,888
                                                   ----------     --      --------      ---------      ---------     ---------
BALANCE AT DECEMBER 31, 1999.....................  78,139,745      8       434,330         (7,563)       (44,142)      382,633
  Comprehensive loss
    Net income...................................          --     --            --             --        312,828       312,828
    Other comprehensive income, net of tax:
      Change in unrealized loss on investments...          --     --            --       (192,000)            --      (192,000)
      Change in foreign currency translation
        adjustment...............................          --     --            --            (36)            --           (36)
                                                                                                                     ---------
    Other comprehensive loss.....................                                                                     (192,036)
                                                                                                                     ---------
  Comprehensive income...........................          --     --            --             --             --       120,792
  Private issuance...............................  10,775,000      1       145,462             --             --       145,463
  Exercise of warrants...........................     429,477     --            --             --             --            --
  Stock issued on acquisition....................     108,000     --         1,067             --             --         1,067
  Exercise of stock options and conversion of
    subordinated notes...........................   3,089,403     --        14,136             --             --        14,136
  Employee stock purchase plan...................     512,707     --         2,554             --             --         2,554
  Tax benefit of stock option transactions.......          --     --         5,008             --             --         5,008
                                                   ----------     --      --------      ---------      ---------     ---------
BALANCE AT DECEMBER 31, 2000.....................  93,054,332     $9      $602,557      $(199,599)     $ 268,686     $ 671,653
                                                   ==========     ==      ========      =========      =========     =========
</TABLE>

          See accompanying notes to consolidated financial statements.
                                        44
<PAGE>   47

                             SONICBLUE INCORPORATED

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                    YEAR ENDED DECEMBER 31,
                                                              -----------------------------------
                                                                2000         1999         1998
                                                              ---------    ---------    ---------
<S>                                                           <C>          <C>          <C>
OPERATING ACTIVITIES
  Net income (loss).........................................  $ 312,828    $ (30,780)   $(113,204)
  Adjustments to reconcile net income (loss) to net cash
    used for operating activities:
    Deferred income taxes...................................    278,160      (61,669)      15,453
    Depreciation............................................     19,420       19,530       18,844
    Amortization............................................     45,364       12,156        8,347
    Write-off of prepaid production capacity................         --           --        4,000
    Loss on disposal of property and equipment..............         --           --       11,308
    Write-off of impaired assets............................         --           --       27,226
    Write-off of acquired technologies......................         --        6,700        8,000
    Write-off of intangibles................................      4,376           --           --
    Gain on sale of shares of manufacturing joint venture...    (14,738)     (22,433)     (26,561)
    Gain on UMC investment..................................   (869,401)          --           --
    Gain on sale of other investments, net of other non-cash
      charges...............................................     (5,555)          --           --
    Equity in (income) losses of investees..................     11,373           54      (17,469)
  Changes in assets and liabilities:
    Accounts receivable.....................................     (8,586)       3,921       36,849
    Inventories.............................................     12,166      (34,704)      60,499
    Prepaid expenses and other assets.......................     21,046        3,655        5,449
    Accounts payable........................................    (18,634)       5,919      (26,573)
    Accrued compensation and benefits.......................      2,093       (2,395)      (2,397)
    Accrued liabilities.....................................     (9,168)       7,492        1,515
    Deferred revenue........................................     (1,666)        (190)      (9,015)
    Income taxes payable....................................       (309)      25,225      (11,576)
                                                              ---------    ---------    ---------
        Net cash used for operating activities..............   (221,231)     (67,519)      (9,305)
                                                              ---------    ---------    ---------
INVESTING ACTIVITIES
  Property and equipment purchases, net.....................     (8,912)      (6,614)      (5,916)
  Purchases of short-term investments.......................    (85,387)    (107,747)    (125,406)
  Sales of short-term and UMC investments...................     51,023      148,937           --
  Maturities of short-term investments......................    119,149           --       66,691
  Investment in real estate partnership.....................         --        7,812           --
  Sale of manufacturing joint venture.......................     14,738       22,433       68,025
  Merger with Diamond.......................................     (6,289)     (22,521)          --
  Equity investment in technology companies.................    (48,689)          --           --
  Other acquisitions........................................     (6,140)          --           --
  Purchase of technology....................................         --           --      (40,000)
  Other assets..............................................         --       (3,642)      (2,276)
                                                              ---------    ---------    ---------
        Net cash from (used for) investing activities.......     29,493       38,658      (38,882)
                                                              ---------    ---------    ---------
FINANCING ACTIVITIES
  Sale of common stock......................................    161,952       57,779        4,371
  Sale of warrant...........................................         --          990           --
  Net borrowings (repayments) of notes payable..............     20,579      (20,752)     (10,000)
  Repayments on equipment financing.........................         --           --       (5,646)
                                                              ---------    ---------    ---------
  Net cash provided by (used for) financing activities......    182,531       38,017      (11,275)
                                                              ---------    ---------    ---------
Effect of exchange rate changes.............................        (36)       5,647           --
                                                              ---------    ---------    ---------
Net increase (decrease) in cash and equivalents.............     (9,243)      14,803      (59,462)
Cash and equivalents at beginning of period.................     45,825       31,022       90,484
                                                              ---------    ---------    ---------
Cash and equivalents at end of period.......................  $  36,582    $  45,825    $  31,022
                                                              =========    =========    =========
SUPPLEMENTAL CASH FLOW INFORMATION
  Interest paid.............................................  $   9,497    $   7,524    $   6,235
  Income taxes paid (refunded), net.........................  $     417    $ (20,022)   $ (15,900)
  Stock issued for acquisitions.............................  $   1,067    $ 183,925    $      --
</TABLE>

          See accompanying notes to consolidated financial statements.
                                        45
<PAGE>   48

                             SONICBLUE INCORPORATED

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

  Organization

     SONICblue Incorporated ("SONICblue" or the "Company"), which was
incorporated on January 9, 1989, designs, develops and markets products for the
digital media, consumer electronics, Internet appliance and home networking
markets. The Company, formerly S3 Incorporated, changed its named to SONICblue
Incorporated on November 15, 2000. The Company's products are used in, and its
business is dependent on, the personal computer industry and the development of
the Internet. Its sales are primarily in the United States, Asia and Europe (see
Note 11). Its products are manufactured, assembled and tested by contract
manufacturers.

  Basis of Presentation

     The consolidated financial statements include the accounts of SONICblue and
its wholly owned subsidiaries. All significant inter-company balances and
transactions have been eliminated. Investments in entities in which the Company
does not have control, but has the ability to exercise significant influence
over operating and financial policies, are accounted for by the equity method.
In January 2001, SONICblue completed the transfer of its graphics chips assets
to S3 Graphics Co., Ltd. a joint venture between VIA Technologies Inc. and a
wholly owned subsidiary of SONICblue.

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates include allowances for doubtful accounts
and customer returns, deferred tax assets, the useful lives of fixed assets and
intangible assets, inventory and other reserves. Actual results could differ
from those estimates, and such differences may be material to the financial
statements.

  Cash, Cash Equivalents and Short-Term Investments

     The Company considers all highly liquid investments with a remaining
maturity of 90 days or less at the time of purchase to be cash equivalents. Cash
equivalents are carried at cost, which approximates fair value. The Company's
short-term investments primarily comprise readily marketable debt and equity
securities with remaining maturities of more than 90 days at the time of
purchase.

     The Company has classified its entire investment portfolio as
available-for-sale. Available-for-sale securities are classified as cash
equivalents or short-term investments and are stated at fair value with
unrealized gains and losses included in accumulated other comprehensive income
(loss). The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization and accretion
are included in interest income. Realized gains and losses are included in other
income (expense). The cost of securities sold is based on the specific
identification method.

  Derivative Financial Instruments

     As of January 1, 2001, the Company adopted Financial Accounting Standards
Board Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities, which was issued in June 1998, and its amendments Statement 137,
Accounting for Derivative Instruments and Hedging Activities-Deferral of the
Effective Date of FASB No. 133 and Statement 138, Accounting for Derivative
Instruments and Certain Hedging Activities, issued in June 1999 and June 2000,
respectively (collectively referred to as Statement 133).

                                        46
<PAGE>   49
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

     As a result of the adoption of Statement 133, the Company will recognize
all derivative financial instruments, such as foreign exchange contracts, in the
consolidated financial instruments at fair value regardless of the purpose or
the intent for holding the instrument. Changes in the fair value of derivative
financial instruments are either recognized periodically in income or in
stockholders' equity as a component of comprehensive income depending on whether
the derivative financial instrument qualifies for hedging accounting, and if so,
whether it qualifies as a fair value hedge or cash flow hedge. Generally,
changes in fair values of derivatives accounted for as fair value hedges are
recorded in income along with the portions of the changes in the fair values of
the hedged items that relate to the hedged risk(s). Changes in fair values of
derivatives accounted for as cash flow hedges, to the extent they are effective
as hedges, are recorded in other comprehensive income net of deferred taxes.
Changes in fair value of derivatives used as hedges of the net investment in
foreign operations are reported in other comprehensive income as part of the
cumulative translation adjustment. Changes in fair value of derivatives not
qualifying as hedges are reported in income.

     As the Company had no derivative financial instruments outstanding as of
December 31, 2000, the adoption of Statement 133 had no impact on the financial
statements of the Company at January 1, 2001.

     Prior to January 1, 2001, the Company used forward foreign exchange
contracts primarily to hedge the value of accounts receivable denominated in
foreign currencies against fluctuations in exchange rates until such receivables
are collected. The Company did not enter into forward foreign exchange contracts
for speculative or trading purposes. The Company's accounting policies for these
contracts were based on the Company's designation of the contracts as hedges of
recorded transactions. Gains and losses on forward foreign exchange contracts
were recognized in income in the same period as losses and gains on the
underlying transactions were recognized and generally offset. As of December 31,
2000, the Company had no foreign exchange forward contracts outstanding. As of
December 31, 1999, the Company had two foreign exchange forward contracts
outstanding. Each contract allowed the Company to sell 275,905,000 New Taiwan
Dollars.

  Inventories

     Inventories consist of raw materials, work in process and finished goods
and are stated at the lower of cost (first-in, first-out) or market. The
Company's products typically experience short life cycles and the Company
estimates the market value of its inventory based on anticipated selling prices
adjusted for completion and selling costs. Should the Company experience a
substantial unanticipated decline in the selling price of its products and/or
demand therefor, a material valuation adjustment and corresponding charge to
operations could result.

     Required payments under the terminated "take or pay" contract with TSMC
(See Note 6) were capitalized and amortized to inventory costs as the related
product was received.

     Inventories consist of:

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                           ------------------
                                                            2000       1999
                                                           -------    -------
                                                             (IN THOUSANDS)
<S>                                                        <C>        <C>
Raw materials............................................  $41,734    $40,132
Work in process..........................................   14,222     10,418
Finished goods...........................................   30,771     46,611
                                                           -------    -------
  Total..................................................  $86,727    $97,161
                                                           =======    =======
</TABLE>

                                        47
<PAGE>   50
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

  Property and Equipment

     Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over estimated useful lives of three to seven years for
machinery and equipment and five to seven years for furniture and fixtures.
Leasehold improvements are amortized using the straight-line method over the
shorter of the lease term or the assets' useful lives.

     Property and equipment consist of:

<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                         --------------------
                                                           2000        1999
                                                         --------    --------
                                                            (IN THOUSANDS)
<S>                                                      <C>         <C>
Machinery and equipment................................  $ 89,621    $ 78,271
Furniture and fixtures.................................     8,480       7,924
Leasehold improvements.................................     9,707       9,490
                                                         --------    --------
  Total................................................   107,808      95,685
Accumulated depreciation and amortization..............   (83,047)    (61,281)
                                                         --------    --------
Property and equipment, net............................  $ 24,761    $ 34,404
                                                         ========    ========
</TABLE>

  Goodwill and Intangible Assets

     Goodwill and intangible assets are stated at cost. Amortization is computed
using the straight-line method over estimated useful lives of two to seven
years.

     Goodwill and intangible assets consist of:

<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                         --------------------
                                                           2000        1999
                                                         --------    --------
                                                            (IN THOUSANDS)
<S>                                                      <C>         <C>
Purchased technology...................................  $  6,800    $  6,800
Trade names............................................     9,600      11,400
Workforce-in-place.....................................     3,500       5,500
Distribution channel relationships.....................    11,500      12,500
Patents................................................    32,000      32,000
Goodwill...............................................   186,331     173,849
                                                         --------    --------
  Total................................................   249,731     242,049
Accumulated amortization...............................   (87,350)    (42,910)
                                                         --------    --------
Goodwill and intangible assets, net....................  $162,381    $199,139
                                                         ========    ========
</TABLE>

  Impairment of Goodwill and Other Long-Lived Assets

     Goodwill and other long-lived assets are reviewed for impairment whenever
events such as product discontinuance, plant closures, product dispositions or
other changes in circumstances indicate that the carrying amount may not be
recoverable. When such events occur, the Company compares the carrying amount of
the assets to undiscounted expected future cash flows. If this comparison
indicates that there is impairment, the amount of the impairment is typically
calculated using discounted expected future cash flows. The discount rate
applied to these cash flows is based on the Company's weighted average cost of
capital, which represents the blended after-tax costs of debt and equity.

                                        48
<PAGE>   51
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

  Foreign Currency Translation

     The Company translates the accounts of its foreign subsidiaries using the
local currency as the functional currency. Consequently, the assets and
liabilities of the Company's subsidiaries and joint venture are translated into
U.S. dollars at current exchange rates and revenues and expenses are translated
at average monthly exchange rates. The resulting translation adjustments are
recorded as a separate component of accumulated other comprehensive income
(loss).

  Revenue Recognition

     In the fourth quarter of 2000, the Company implemented Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," or SAB 101,
retroactively to January 1, 2000. SAB 101 requires that the following criteria
must be met before revenues can be recorded: (a) persuasive evidence that an
arrangement exists, (b) delivery has occurred or services have been rendered,
(c) the seller's price to the buyer is fixed or determinable, and (d)
collectibility is reasonably assured. There was no cumulative effect associated
with implementing SAB 101.

     Revenue from product sales made directly to customers is generally
recognized upon shipment. Accruals for estimated sales returns and allowances
are recorded at the time of sale. Certain of the Company's sales are made to
distributors under agreements allowing price protection and rights of return on
unsold products by the distributors. The Company defers recognition of revenue
on such sales until the product is sold by the distributors.

  Concentration of Credit Risk

     Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents, short-term
investments, trade accounts receivable and foreign exchange contracts. The
Company invests only in high credit quality short-term debt instruments and
limits the amount of credit exposure to any one entity. A majority of the
Company's trade receivables result from sales to manufacturers in the computer
industry. Three customers collectively accounted for more than 43% and 52% of
the Company's accounts receivable balance at December 31, 2000 and 1999,
respectively. The Company performs ongoing credit evaluations of its customers'
financial condition and limits the amount of credit extended when deemed
necessary but generally requires no collateral. The Company maintains reserves
for potential credit losses, and all such losses to date have been within
management's expectations.

  Research and Development Expenses

     Research and development is expensed as incurred. To the extent research
and development costs include the development of computer software, the Company
believes that software development is an integral part of the product design and
expenses all such costs as incurred.

  Advertising Expenses

     The Company accounts for advertising costs as an expense in the period in
which it is incurred. Total advertising expenses were $14.0 million, $3.7
million, and $7.9 million for each of the years ending December 31, 2000, 1999
and 1998, respectively.

  Stock-Based Compensation

     The Company grants stock options for a fixed number of shares to employees
with an exercise price equal to the fair value of the shares at the date of
grant. The Company accounts for stock option grants in accordance with the
intrinsic value method because the Company believes the alternative fair value
                                        49
<PAGE>   52
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

accounting requires the use of option valuation models that were not developed
for use in valuing employee stock options. Under the intrinsic value method no
compensation expense is recognized when the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant.

  Recently Issued Accounting Standards

     In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"), Accounting
for Certain Transactions Involving Stock Compensation, an interpretation of APB
Opinion No. 25. FIN 44 clarifies the application of Opinion No. 25 for (a) the
definition of an employee for purposes of applying Opinion No. 25, (b) the
criteria for determining whether a plan qualifies as a non-compensatory plan,
(c) the accounting consequences of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. FIN 44 became effective
July 2, 2000, but certain conclusions cover specific events that occur after
either December 15, 1998, or January 12, 2000. The adoption of FIN 44 did not
have a material impact on the Company's financial position, results of
operations or cash flows.

  Reclassifications

     Certain prior year amounts have been reclassified to conform to the current
year presentation. Such reclassifications had no effect on net income (loss) or
stockholders' equity.

 2. BUSINESS COMBINATIONS

  Diamond Multimedia Systems

     On September 24, 1999, the Company completed the acquisition of all of the
outstanding common stock of Diamond Multimedia Systems, Inc. ("Diamond").
Approximately 18.7 million shares of SONICblue common stock were issued to
Diamond shareholders and approximately 1.3 million options were assumed. At the
time of the acquisition, Diamond designed, developed, manufactured and marketed
multimedia and connectivity products for personal computers. The transaction was
accounted for as a purchase and, accordingly, the results of operations of
Diamond have been included in the consolidated financial statements since the
date of acquisition.

     The purchase price of approximately $215 million included $172 million of
stock, $12 million in stock option costs at fair value, cash payment of $20
million and approximately $11 million in expenses of the transaction. The
purchase price was allocated as follows: $1.2 million to the estimated fair
value of Diamond net liabilities assumed (as of September 24, 1999), $6.7
million to purchased in-process research and development, $6.8 million to
purchased existing technology, $11.4 million to trade names, $5.5 million to
workforce-in-place, $12.5 million to Diamond distribution channel relationships
and $173.8 million to goodwill. Goodwill was recorded as a result of
consideration paid in excess of the fair value of net tangible and

                                        50
<PAGE>   53
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

intangible assets acquired. Goodwill and identified acquisition related
intangible assets are amortized on a straight-line basis over the periods
indicated below.

     The intangible assets and goodwill acquired have estimated useful lives as
follows:

<TABLE>
<CAPTION>
                                                               ESTIMATED
                                                              USEFUL LIFE
                                                              -----------
<S>                                                           <C>
Purchased existing technology...............................  2 - 4 years
Trade names.................................................      7 years
Workforce-in-place..........................................      4 years
Diamond distribution channel relationships..................      5 years
Goodwill....................................................      5 years
</TABLE>

     The $6.7 million assigned to and written off as purchased in-process
research and development was determined by identifying research projects in
areas for which technological feasibility had not been established. The value
was determined by estimating the expected cash flows from the projects once
commercially viable, discounting the net cash flows back to their present value
and then applying a percentage of completion to the calculated value. The $6.7
million expense is included in other operating expense in the consolidated
statements of operations for the year ended December 31, 1999.

     In conjunction with the 2000 restructuring, the Company wrote off $4.4
million net book value of the acquired intangibles. See Note 14.

  Purchase of Assets of Number Nine

     On February 1, 2000, the Company completed the acquisition of substantially
all of the assets of Number Nine Visual Technology Corporation ("Number Nine").
The acquisition was accounted for as a purchase. The purchase price of $5.3
million included $5.1 million of cash and $0.2 million in estimated expenses of
the transaction. The purchase price was allocated as follows: $0.7 million to
the estimated fair value of Number Nine net assets (as of February 1, 2000),
$0.5 million to workforce-in-place and $4.1 million to goodwill. Goodwill is
recorded as a result of consideration paid in excess of the fair value of net
tangible and intangible assets acquired. Goodwill and identified acquisition
related intangible assets are amortized on a straight-line basis over five
years. The allocation of the purchase price to intangibles was based upon
management's estimates.

  Purchase of empeg

     In November 2000, SONICblue acquired U.K. digital audio equipment
manufacturer Empeg Limited, known as empeg. The acquisition was accounted for as
a purchase. The purchase price of $1.9 million included $0.8 million of cash and
$1.1 million of SONICblue stock issued at fair value. The purchase price was
allocated as follows: $0.4 million to the estimated fair value of empeg net
liabilities assumed and $2.3 million to goodwill. Goodwill is recorded as a
result of the consideration paid in excess of the fair value of net tangible and
intangible assets acquired. Goodwill is amortized on a straight-line basis over
five years. The allocation of the purchase price was based upon management's
estimates.

                                        51
<PAGE>   54
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

 3. FINANCIAL INSTRUMENTS

     The following is a summary of available-for-sale securities:

<TABLE>
<CAPTION>
                                                                   UNREALIZED    UNREALIZED
                                          AMORTIZED     MARKET      HOLDING       HOLDING
                                            COST        VALUE        GAINS         LOSSES
                                          ---------    --------    ----------    ----------
                                                           (IN THOUSANDS)
<S>                                       <C>          <C>         <C>           <C>
DECEMBER 31, 2000:
Corporate Debt Securities:
  Money market mutual funds.............  $ 13,753     $ 13,753      $   --       $     --
  Corporate bonds.......................     2,312        2,324          12             --
                                          --------     --------      ------       --------
          Total Corporate Debt
            Securities..................    16,065       16,077          12             --
Corporate Equity Securities.............   525,905      232,369          --        293,536
U.S. Government Securities..............     3,004        2,997          --              7
                                          --------     --------      ------       --------
                                          $544,974     $251,443      $   12       $293,543
                                          ========     ========      ======       ========
Included in short-term investments......  $531,221     $237,690      $   12       $293,543
Included in cash and cash equivalents...    13,753       13,753          --             --
                                          --------     --------      ------       --------
                                          $544,974     $251,443      $   12       $293,543
                                          ========     ========      ======       ========
DECEMBER 31, 1999:
Corporate Debt Securities:
  Money market mutual funds.............  $ 13,240     $ 13,240      $   --       $     --
  Commercial paper......................       894          897           3             --
  Corporate bonds.......................    23,141       22,797          --           (344)
  Municipal bonds.......................     1,829        1,815          --            (14)
  Market auction preferreds.............     7,000        7,000          --             --
  Certificates of deposit...............     5,024        5,000          --            (24)
                                          --------     --------      ------       --------
          Total Corporate Debt
            Securities..................    51,128       50,749           3           (382)
Corporate Equity Securities.............    19,038       20,462       2,231           (807)
U.S. Government Securities..............     8,901        8,844          --            (57)
                                          --------     --------      ------       --------
                                          $ 79,067     $ 80,055      $2,234       $ (1,246)
                                          ========     ========      ======       ========
Included in short-term investments......  $ 57,933     $ 58,918      $2,231       $ (1,246)
Included in cash and cash equivalents...    21,134       21,137           3             --
                                          --------     --------      ------       --------
                                          $ 79,067     $ 80,055      $2,234       $ (1,246)
                                          ========     ========      ======       ========
</TABLE>

     All debt securities had a maturity of less than one year at December 31,
2000 and 1999. The carrying values and fair values of the Company's financial
instruments are as follows:

<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                        --------------------------------------------------
                                                 2000                       1999
                                        -----------------------    -----------------------
                                        CARRYING     ESTIMATED     CARRYING     ESTIMATED
                                         AMOUNT      FAIR VALUE     AMOUNT      FAIR VALUE
                                        ---------    ----------    ---------    ----------
                                                          (IN THOUSANDS)
<S>                                     <C>          <C>           <C>          <C>
Convertible subordinated notes........  $(103,300)    $(70,915)    $(103,500)    $(96,131)
Foreign currency forward exchange
  contracts...........................         --           --            --         (386)
</TABLE>

     The carrying value of cash and cash equivalents, short-term investments and
notes payable approximates fair value. The fair values of convertible
subordinated notes and foreign currency forward exchange contracts are estimated
based on quoted market prices.

                                        52
<PAGE>   55
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

 4. INVESTMENTS

  Investment in UMC

     During 1995, the Company entered into two long-term manufacturing capacity
arrangements. The Company entered into an agreement with United Microelectronics
Corporation ("UMC") and Alliance Semiconductor Corporation to form United
Semiconductor Corporation ("USC"), a separate Taiwanese company, for the purpose
of building and managing a semiconductor manufacturing facility in Taiwan,
Republic of China. The Company invested a total of $89.4 million for its equity
interest of 23.75%. On December 31, 1997, the Company entered into an agreement
with UMC to sell to UMC 80 million shares of stock of USC for a purchase price
of 2.4 billion New Taiwan Dollars. The Company received approximately $68.0
million in cash in January 1998. As a result of the sale to UMC, SONICblue's
percentage ownership in USC decreased to 15.75%. The Company had the right to
purchase up to 31.25% of the output from the foundry.

     In June 1999, the Company announced that it would receive $42.0 million
(based on the June 1999 exchange rate) from UMC for a patent license and release
of contingencies on the previous USC stock sale from UMC. Payments were received
over five fiscal quarters beginning in the quarter ended June 30, 1999. Under
the terms of the agreement, SONICblue licensed 29 patents covering multimedia
products and integrated circuit manufacturing technology for use in products
manufactured by UMC. The Company agreed to waive rights to its USC board seat
and determined that it no longer could exercise significant influence over the
financial and operating decisions of USC. Accordingly, in June 1999, the Company
ceased accounting for its investment in USC using the equity method of
accounting.

     In June 1999, UMC announced that it would provide one share of UMC common
stock for every share of USC common stock. The transaction was a result of UMC's
foundry consolidation plans whereby USC, United Integrated Circuits Corporation,
United Silicon Incorporated and UTEK Semiconductor Corporation, were merged into
UMC.

     In January 2000, USC merged with UMC and, as a result of the merger,
SONICblue received 252 million shares of UMC common stock in exchange for 252
million USC shares. The Company also received a 20% stock dividend, or
approximately 50.4 million shares of UMC stock, in April 2000, increasing the
Company's holdings to approximately 302 million shares of UMC stock. The Company
sold 15 million shares of UMC stock in 2000 on the Taiwan Stock Exchange. Under
the terms of the USC merger with UMC, 50% of the UMC shares received by the
Company are classified as restricted because they are subject to restrictions on
their sale that lapse over a three-year period from the date of the merger. At
December 31, 2000, approximately 126 million shares were restricted and are
recorded as a long-term investment at cost. The portion of the investment that
is not subject to restriction is adjusted to fair market value at each reporting
date and classified as short-term investments. Approximately 161 million of the
unrestricted shares are recorded as a current asset and are valued at market in
accordance with Statement of Financial Accounting Standards No. 115.
Approximately 100 million of the unrestricted shares have been pledged to secure
a domestic loan facility. See Note 6.

     At December 31, 2000, the market value of both the short-term and long-term
investment in UMC had declined $519.8 million below its original cost basis. It
was determined that this decline was related to the downturn in the
semiconductor industry as a whole and was temporary in nature due to the
historically cyclical nature of the industry. The available-for-sale portion of
the investment was marked-to-market through other comprehensive income.

     Subsequent to the year-end, the market value of the investment in UMC
remained significantly below cost. There is a great deal of uncertainty
regarding when the semiconductor industry will recover from this down cycle. The
Company is continuing to evaluate its need to reduce the value of its
investment. Should the

                                        53
<PAGE>   56
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

Company conclude that the decline in value is other than temporary, it will
report a loss in other income and expense at that time.

  Interest in Real Estate Partnership

     In 1995, the Company entered into a limited partnership arrangement (the
"partnership") with a developer to obtain a ground lease and develop and operate
the Company's current Santa Clara facilities. The Company invested $2.1 million
for a 50% limited partnership interest. On June 29, 1999, the Company entered
into an agreement to assign to the general partner the Company's entire interest
in the partnership for $7.8 million. The gain on the assignment of the Company's
partnership interest is being recognized over the term of the facilities lease,
which expires in 2008.

  Investment in RioPort

     In October 1999, RioPort, Inc. ("RioPort"), which was a wholly owned
subsidiary, sold shares of its preferred stock to third party investors. As a
result, the Company retains a minority investment in RioPort and accounts for
its investment using the equity method of accounting. In addition, in November
1999, as part of the formation of the partnership, the Company transferred its
ownership of OneStep, LLC to RioPort in exchange for $10.9 million, which was
the Company's acquisition cost of OneStep in July 1999.

     In June 2000, RioPort sold additional preferred stock. As part of this
financing, the Company invested an additional $10.7 million in RioPort,
maintaining its percentage ownership of RioPort.

     RioPort is developing an integrated platform for acquiring, managing and
experiencing music and spoken audio programming from the Internet.

  Investment in S3-VIA, Inc.

     In November 1999, the Company established a joint venture with VIA
Technologies, Inc. ("VIA") to bring high-performance integrated graphics and
core logic chip sets to the volume OEM desktop and notebook PC markets. The
venture, S3-VIA, Inc. has joint funding, exclusive access to both companies'
technology and distribution rights for developed products between SONICblue and
VIA. The Company owns 50.1% of the voting common stock of the joint venture.
Accordingly, the Company has consolidated the accounts of S3-VIA, Inc. in its
consolidated financial statements. In January 2001, SONICblue's interest in
S3-VIA was transferred, along with SONICblue's graphics chip business, to S3
Graphics Co., Ltd., another joint venture between VIA and a wholly owned
subsidiary of SONICblue as described in Note 17.

 5. CONVERTIBLE SUBORDINATED NOTES

     In September 1996, the Company completed a private placement of $103.5
million of convertible subordinated notes. The notes mature in 2003. Interest is
payable semi-annually at 5 3/4% per annum. The notes are convertible at the
option of the holders into the Company's common stock at an initial conversion
price of $19.22 per share, subject to adjustment. During 2000, $0.2 million in
notes were converted into common stock. Beginning in October 1999, the notes are
redeemable at the option of the Company at an initial redemption price of 102%
of the principal amount. The Company has reserved 5,374,610 shares of common
stock for the conversion of these notes. Offering costs of approximately $3.4
million are included in other assets and are amortized on a straight-line basis
over the term of the notes.

 6. LINE OF CREDIT AND NOTES PAYABLE

     In 1995 the Company expanded and formalized its relationship with Taiwan
Semiconductor Manufacturing Company ("TSMC") to provide additional capacity over
the period from 1996 to 2000. The agreement
                                        54
<PAGE>   57
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

with TSMC requires the Company to make annual advance payments to be applied
against the following year's capacity. The Company signed promissory notes to
secure these payments over the term of the agreement. In July 2000, the Company
terminated the "take or pay" contract with TSMC and a foundry relationship with
UMC. The Company's agreement with TSMC provided capacity through 2002 and
required the Company to make annual advance payments to purchase specified
capacity to be applied against the following year's capacity or to forfeit
advance payments against those amounts. The Company received a refund of
approximately $4.8 million and the notes payable were cancelled.

     At December 31, 2000, the Company had a $70.0 million domestic bank
facility permitting borrowings at the rate of LIBOR plus 2%. This bank facility
expires in 2001. The covenants covering this debt agreement pertain to minimum
levels of collateral coverage and tangible net worth, quarterly profitability
and minimum levels of liquidity. As of December 31, 2000, the Company was in
compliance with all loan covenants. The Company has pledged 100 million UMC
shares to secure the loan facility. Additionally, the Company has credit
facilities under foreign lines of credit. The Company has a foreign line of
credit of 10 million Deutsche Marks (approximately $4.8 million at December 31,
2000) and a foreign line of credit of 3.0 million British Pounds (approximately
$4.5 million at December 31, 2000). Borrowings, included in Notes Payable, were
$72.2 million under these facilities at December 31, 2000.

     As of December 31, 2000, the Company's future payments on debt related to
notes payable, lines of credit and capital lease obligations are due in 2001,
therefore all amounts have been classified as current.

 7. STOCKHOLDERS' EQUITY

  Preferred Stock

     The number of shares of preferred stock authorized for issuance is
5,000,000, par value of $0.0001 per share. The preferred stock may be issued
from time to time in one or more series. The Board of Directors is authorized to
provide rights, preferences, privileges and restrictions of the shares of such
series. As of December 31, 2000 and 1999, no shares of preferred stock had been
issued.

  Stockholder Rights Plan

     On May 14, 1997, the Board adopted a Stockholder Rights Plan. To implement
the plan, SONICblue's Board declared a dividend of one preferred stock purchase
right (a "Right") for each outstanding share of SONICblue common stock held of
record on June 1, 1997. Each Right represents a contingent right to purchase,
under certain circumstances, a fractional share of a newly created series of
SONICblue preferred stock. The Rights would become exercisable and trade
independently from SONICblue common stock upon the public announcement of the
acquisition by a person or group of 15% or more of SONICblue's common stock, or
ten days after commencement of a tender or exchange offer for SONICblue common
stock that would result in the acquisition of 15% or more of SONICblue's common
stock. In the event one of the limited conditions is triggered, each Right
entitles the registered holder to purchase one one-thousandth of a share of
preferred stock at an exercise price of $85.00 per Right. The Board of Directors
may redeem the Rights at $0.01 per Right pursuant to the plan. The Rights expire
May 14, 2007.

  Employee Stock Purchase Plans

     Under the terms of the Merger Agreement with Diamond, the Company assumed
Diamond's 1995 Employee Stock Purchase Plan (the "1995 Purchase Plan"). Upon
consummation of the Merger, each option under the 1995 Purchase Plan was
converted into the right to purchase shares of SONICblue's common stock. The
Company reserved 52,000 shares of common stock for the offering period in effect
at the date of the merger. This offering period concluded on October 31, 1999,
and no new offering periods will be commenced

                                        55
<PAGE>   58
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

under the 1995 Purchase Plan. The Company's 1993 Employee Stock Purchase Plan
permits eligible employees to purchase shares at a price equal to 85% of the
lower of the fair market value at the beginning or end of the purchase period.
At the Company's Annual Meeting of Stockholders held on May 26, 2000, an
amendment to the Company's 1993 Employee Stock Purchase Plan increasing the
number of shares available for sale from 2.8 million to 4.8 million was
approved. At December 31, 2000, 3,026,367 shares have been issued under the
plans and 1,825,563 shares have been reserved for future issuance.

  Stock Plan

     The 1989 Stock Plan was established for the grant of incentive or
nonstatutory stock options and the direct award or sale of shares to employees,
directors and consultants. Incentive stock options must be granted at not less
than fair market value at the date of grant. The exercise price of nonstatutory
options and the share price for shares sold generally may be no less than 85% of
fair market value at the date of the grant or sale. In connection with the
merger with Diamond, each outstanding Diamond stock option was assumed by
SONICblue and converted into an option to acquire shares of SONICblue common
stock on the same terms and conditions (including any provisions for
acceleration) as were applicable to that stock option under the applicable
Diamond stock option plan in effect prior to the merger. At December 31, 2000,
37,426,489 shares of common stock have been authorized for issuance, 19,880,578
shares of common stock are reserved for issuance and 4,845,335 shares were
available for future grant under the 1989 Stock Plan.

     A summary of stock option activity is as follows:

<TABLE>
<CAPTION>
                                                    NUMBER      WEIGHTED AVERAGE
                                                  OF SHARES     PRICE PER SHARE
                                                  ----------    ----------------
<S>                                               <C>           <C>
BALANCE, DECEMBER 31, 1997......................  10,051,840         $ 6.28
Options granted.................................   9,609,391           4.26
Options exercised...............................    (560,546)          3.57
Options cancelled...............................  (4,057,968)          7.09
                                                  ----------
BALANCE, DECEMBER 31, 1998......................  15,042,717           4.86
Options granted and assumed.....................   7,920,117           8.50
Options exercised...............................  (3,390,645)          5.24
Options cancelled...............................  (2,367,990)          6.51
                                                  ----------
BALANCE, DECEMBER 31, 1999......................  17,204,199           6.22
Options granted.................................   4,248,953          13.90
Options exercised...............................  (3,089,403)          5.38
Options cancelled...............................  (3,328,506)          8.90
                                                  ----------
BALANCE, DECEMBER 31, 2000......................  15,035,243           7.93
                                                  ==========
</TABLE>

     Options to purchase 6,990,819, 6,729,122, and 4,400,697 shares were
exercisable at December 31, 2000, 1999, and 1998, respectively, with a weighted
average exercise price of $6.03, $5.24, and $5.89 respectively.

     Options generally vest over a period of four years and generally become
exercisable beginning either six months or one year from the date of employment
or grant. Options generally expire ten years from the date of grant.

  Stock-Based Compensation

     Under the intrinsic value method, the Company generally recognizes no
compensation expense with respect to stock-based awards to employees. The
Company is required to present pro forma information regarding net income (loss)
and net income (loss) per share, as if the Company had accounted for its stock-

                                        56
<PAGE>   59
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

based awards to employees under the fair value method. The fair value of the
Company's stock-based awards to employees was estimated using the Black-Scholes
option valuation model. The Black-Scholes option valuation model was developed
for use in estimating fair value of traded options that have no vesting
restrictions and are fully transferable. The Black-Scholes model requires the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock-based awards to employees have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its
stock-based awards to employees.

     The following table summarizes the ranges of outstanding and exercisable
options at December 31, 2000:

<TABLE>
<CAPTION>
                         OPTIONS OUTSTANDING
                 ------------------------------------    OPTIONS EXERCISABLE
                                WEIGHTED                ----------------------
                                 AVERAGE     WEIGHTED                 WEIGHTED
                                REMAINING    AVERAGE                  AVERAGE
   RANGE OF        NUMBER      CONTRACTUAL   EXERCISE     NUMBER      EXERCISE
EXERCISE PRICES  OUTSTANDING   LIFE (YRS)     PRICE     EXERCISABLE    PRICE
---------------  -----------   -----------   --------   -----------   --------
<S>              <C>           <C>           <C>        <C>           <C>
$ 0.12 - $ 4.38   4,275,142       6.84        $3.28      2,645,459     $ 3.24
  4.39 -   7.50   4,255,142       6.95         5.78      3,020,175       5.69
  7.51 -  13.19   3,817,761       8.91        10.15        878,753      10.37
 13.20 -  36.66   2,687,198       8.87        15.60        446,432      16.33
                 ----------                              ---------
  0.12 -  36.66  15,035,243       7.76         7.93      6,990,819       6.03
                 ==========                              =========
</TABLE>

     The fair value of the Company's stock-based awards to employees was
estimated assuming no expected dividends and the following weighted-average
assumptions:

<TABLE>
<CAPTION>
                                                                        EMPLOYEE STOCK PURCHASE
                                             STOCK OPTION PLAN                   PLAN
                                        ---------------------------   ---------------------------
                                         2000      1999      1998      2000      1999      1998
                                        -------   -------   -------   -------   -------   -------
<S>                                     <C>       <C>       <C>       <C>       <C>       <C>
Expected life from vest date            0.5 yrs   0.5 yrs   0.5 yrs   0.0 yrs   0.0 yrs   0.0 yrs
Volatility............................    81%       83%       84%       81%       83%       84%
Risk-free interest rate...............   6.2%      5.4%      4.9%      5.8%      4.9%      5.0%
</TABLE>

     The weighted-average estimated fair value of stock options granted during
2000, 1999, and 1998 was $7.80, $4.95 and $2.21 per share, respectively. The
weighted-average estimated fair value of shares purchased under the Employee
Stock Purchase Plan during 2000, 1999, and 1998 was $3.08, $2.87, and $3.46 per
share, respectively.

     For pro forma purposes, the estimated fair value of the Company's
stock-based awards to employees is generally amortized over the vesting period
of four years (for options) and the offering period (for stock purchases under
the Employee Stock Purchase Plan). The pro forma information is as follows:

<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                            ------------------------------------------
                                               2000           1999            1998
                                            -----------    -----------    ------------
                                             (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                         <C>            <C>            <C>
Pro forma net income (loss)...............   $297,286       $(42,178)      $(127,967)
Pro forma per share amounts:
  Basic...................................   $   3.29       $  (0.71)      $   (2.51)
  Diluted.................................   $   3.15       $  (0.71)      $   (2.51)
</TABLE>

                                        57
<PAGE>   60
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

  Intel Warrant

     In December 1998, the Company entered into an agreement pursuant to which
it agreed to issue to Intel Corporation a warrant to purchase 1,000,000 shares
of the Company's common stock at an exercise price of $9.00 per share. The
purchase price for the warrant was $1.0 million. Intel exercised this warrant in
February 2000 on a cashless basis for a net issuance of 429,477 shares.

 8. LEASES AND COMMITMENTS

  Operating Leases

     The Company occupies facilities in several countries including the United
States, Canada, France, Germany, Japan, Korea, Republic of China, Singapore and
the United Kingdom and is obligated under leases expiring through 2008. Under
the leases, the Company is responsible for insurance, maintenance and property
taxes. During 1995, the Company entered into a limited partnership arrangement
with a developer to obtain a ground lease and develop and operate the Company's
Santa Clara, California facilities. See Note 4. In January 1997, prior to the
expiration of the lease terms of the previous facilities, the Company relocated
its principal administrative facilities to its present Santa Clara facilities,
at which time the Company's minimum operating lease payment of $369,000
commenced for the initial 12-year term. During 1997, the Company sublet a
portion of its previous facilities for the remaining lease terms and negotiated
a lease termination on the other two previous facilities. During 1998, the
Company sublet a portion of its current facilities through 2008.

     Future minimum annual payments under operating leases are as follows

<TABLE>
<CAPTION>
                                                              OPERATING LEASES
                                                              ----------------
                                                               (IN THOUSANDS)
<S>                                                           <C>
2001........................................................      $10,566
2002........................................................        9,719
2003........................................................        8,865
2004........................................................        7,784
2005........................................................        7,598
Thereafter..................................................       19,490
                                                                  -------
          Total minimum lease payments......................      $64,019
                                                                  =======
</TABLE>

     The total of minimal rentals to be received in the future under
non-cancelable subleases is $35.8 million as of December 31, 2000.

     Rent expense for 2000, 1999 and 1998, was $10.9 million, $10.1 million and
$8.9 million, respectively. Sublease income for 2000, 1999 and 1998 was $4.1
million, $4.4 million and $2.6 million, respectively. Net rent expense for 2000,
1999, and 1998 was $6.8 million, $5.7 million and $6.3 million, respectively.

                                        58
<PAGE>   61
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

 9. INCOME TAXES

     The provision (benefit) for income taxes consists of:

<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                     --------------------------------
                                                       2000        1999        1998
                                                     --------    --------    --------
                                                              (IN THOUSANDS)
<S>                                                  <C>         <C>         <C>
CURRENT TAX EXPENSE:
  Federal..........................................  $     --    $     --    $(20,802)
  State............................................        --          --          --
  Foreign..........................................        88         618          --
                                                     --------    --------    --------
                                                           88         618     (20,802)
                                                     --------    --------    --------
DEFERRED TAX EXPENSE:
  Federal..........................................   210,620     (43,173)      4,995
  State............................................    70,770      (5,361)      3,851
  Foreign..........................................        --          --          --
                                                     --------    --------    --------
                                                      281,390     (48,534)      8,846
                                                     --------    --------    --------
  Total............................................  $281,478    $(47,916)   $(11,956)
                                                     ========    ========    ========
</TABLE>

     Loss from foreign operations was $31.0 million, nil, and $15.1 million in
2000, 1999 and 1998 respectively. The tax benefits resulting from disqualifying
dispositions of shares acquired under the Company's incentive stock option plan
and from the exercise of non-qualified stock options reduced taxes payable as
shown by $5.0 million in 2000 and $2.9 million in 1999 which amounts are
included in additional paid-in capital. There was no tax benefit in 1998
associated with stock option activity.

     The difference between the provision for taxes on income and the amount
computed by applying the federal statutory income tax rate to income before
taxes is explained below:

<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                     --------------------------------
                                                       2000        1999        1998
                                                     --------    --------    --------
                                                              (IN THOUSANDS)
<S>                                                  <C>         <C>         <C>
Tax computed at 35%................................  $208,007    $(27,544)   $(43,806)
Nondeductible goodwill.............................    15,554       4,269          --
State income taxes, net of federal effect..........    46,000          --          --
Tax credits........................................    (3,000)         --      (2,800)
Equity loss of investee............................     3,981           2      (6,114)
Losses not benefited (benefited)...................    10,150     (24,643)     40,729
Other..............................................       786          --          35
                                                     --------    --------    --------
Provision for income taxes.........................  $281,478    $(47,916)   $(11,956)
                                                     ========    ========    ========
Effective tax rate.................................      47.4%       60.9%        9.6%
                                                     ========    ========    ========
</TABLE>

                                        59
<PAGE>   62
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

     Significant components of the Company's deferred income tax asset are as
follows:

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                2000        1999
                                                              ---------    -------
                                                                 (IN THOUSANDS)
<S>                                                           <C>          <C>
Deferred tax assets:
  Reserves not currently deductible.........................  $  14,555    $10,255
  Accrued liabilities.......................................         --      4,326
  Deferred revenue..........................................        489      4,978
  Compensation expense not currently deductible.............      3,106      3,726
  Depreciation/amortization.................................     16,151     11,874
  Foreign net operating loss carryforwards..................      7,300      9,023
  Federal net operating loss carryforwards..................    159,825    101,277
  State net operating loss carryforwards....................     13,400      4,702
  Federal credit carryforwards..............................     10,293      8,275
  State credit carryforwards................................      4,662      3,650
  Other.....................................................     11,728      7,785
                                                              ---------    -------
          Total deferred tax assets.........................    241,509    169,871
  Valuation allowance for deferred tax assets...............    (80,568)   (60,868)
                                                              ---------    -------
          Net deferred tax assets...........................    160,941    109,003
                                                              ---------    -------
Deferred tax liabilities:
  Earnings and gain from foreign joint venture..............   (243,754)   (12,900)
  Purchased intangibles.....................................     (6,984)   (17,122)
  Other.....................................................     (4,906)    (2,865)
                                                              ---------    -------
          Total deferred tax liabilities....................   (255,644)   (32,887)
                                                              ---------    -------
          Net deferred tax liability........................  $ (94,703)   $76,116
                                                              =========    =======
</TABLE>

     The foreign net operating loss carryforwards do not expire. The federal net
operating loss and credit carryforwards expire beginning in 2018 and 2011,
respectively. The state net operating loss and credit carryforwards expire
beginning in 2002 and 2005, respectively.

     The valuation allowance at December 31, 2000 includes $18 million
attributable to changes in unrealized loss on investments, and will be credited
to accumulated other comprehensive income/loss when realized. The balance of the
valuation allowances at December 31, 2000 and 1999 relates to tax carryforwards
of a purchased subsidiary, the realization of which will first reduce goodwill,
then other non-current intangible assets related to the acquisition. The change
in the valuation allowance was $19.7 million and $20.1 million for December 31,
2000 and 1999, respectively.

10. EMPLOYEE BENEFIT PLANS

     The Company implemented a non-qualified cash profit sharing plan in 1994
under which all employees of the Company, including officers, are eligible to
receive, on an annual basis, an equal cash bonus based on pretax profits,
prorated for service with the Company. No payments were made under this plan in
2000, 1999 or 1998.

     The Company has a 401(k) tax-deferred savings plan whereby all employees
meeting certain age and service requirements may contribute up to 20% of their
eligible compensation (up to a maximum allowed

                                        60
<PAGE>   63
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

under IRS rules). The Company, at the discretion of the Board of Directors, may
make contributions. No contributions by the Company have been made to the plan
since its inception.

11. EXPORT SALES AND SIGNIFICANT CUSTOMERS

     The Company reports financial and descriptive information about operating
segments for which separate financial information is made available to and
evaluated regularly by the chief operating decision maker, its Chief Executive
Officer ("CEO"). During 2000, the CEO reviewed financial information presented
on a consolidated basis for purposes of making operating decisions and assessing
financial performance.

     The Company's primary operations are located in the United States. The
Company sells its products into the personal computer market primarily in the
United States, Asia and Europe. Export sales accounted for 56%, 70% and 89% of
net sales in 2000, 1999 and 1998, respectively. Approximately 33%, 35% and 29%
of export sales in 2000, 1999 and 1998, respectively, were to affiliates of
United States customers. In 2000, 2% and 20% of export sales were shipped to
Hong Kong and Taiwan, respectively. In 1999, 8% and 16% of export sales were
shipped to Hong Kong and Taiwan, respectively. In 1998, 18% and 55% of export
sales were shipped to Hong Kong and Taiwan, respectively. One customer accounted
for 21% of net sales in 2000. Three customers accounted for 19%, 10% and 9%,
respectively, of net sales in 1999. Three customers accounted for 39%, 14% and
13%, respectively, of net sales in 1998.

12. CONTINGENCIES

     Since November 1997, a number of complaints have been filed in federal and
state courts seeking unspecified damages on behalf of an alleged class of
persons who purchased shares of SONICblue's common stock at various times
between April 18, 1996 and November 3, 1997. The complaints name as defendants
SONICblue, certain of its officers and former officers, and certain directors of
SONICblue, asserting that they violated federal and state securities laws by
misrepresenting and failing to disclose certain information about SONICblue's
business. In addition, certain stockholders have filed derivative actions in the
state courts of California and Delaware seeking recovery on behalf of SONICblue,
alleging, among other things, breach of fiduciary duties by such individual
defendants. The plaintiffs in the derivative action in Delaware have not taken
any steps to pursue their case. The derivative cases in California State court
have been consolidated, and plaintiffs have filed a consolidated amended
complaint. The court has entered a stipulated order in those derivative cases
suspending court proceedings and coordinating discovery in them with discovery
in the class actions in California State courts. On plaintiffs' motion, the
federal court has dismissed the federal class actions without prejudice. The
class actions in California State court have been consolidated, and plaintiffs
have filed a consolidated amended complaint. SONICblue has answered that
complaint. Discovery is proceeding. On January 22, 2001, four of the insurance
carriers which issued directors and officers insurance to SONICblue filed suit
against all parties named as defendants in the securities litigation, claiming
that the carriers have no obligation to provide coverage under the California
Insurance Code. While management intends to defend the actions against SONICblue
vigorously, there can be no assurance that an adverse result or settlement with
regard to these lawsuits would not have a material adverse effect on SONICblue's
financial condition or results of operations.

     SONICblue has received from the Securities and Exchange Commission a
request for information relating to SONICblue's restatement announcement in
November 1997. SONICblue has responded and intends to continue to respond to
such requests.

     SONICblue has also been defending several putative class action lawsuits
naming Diamond, which were filed in June and July 1996 and June 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain former executive officers and
directors of Diamond are also named as defendants. The plaintiffs purport to
represent a class of all persons who
                                        61
<PAGE>   64
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

purchased Diamond's common stock between October 18, 1995 and June 20, 1996, or
the Class Period. The complaints allege claims under the federal securities laws
and California law. The plaintiffs allege that Diamond and the other defendants
made various material misrepresentations and omissions during the Class Period.
The complaints do not specify the amount of damages sought. On March 24, 2000,
the District Court for the Northern District of California dismissed the federal
action without prejudice. The parties have tentatively agreed to settle this
matter, subject to final documentation and court approval, for a payment of
$15.0 million. SONICblue funded $4.5 million of the settlement on November 1,
2000. SONICblue previously accrued this amount in connection with the merger
with Diamond. SONICblue believes that Diamond's insurance covers the remaining
$10.5 million of the settlement and Diamond's insurers have funded that amount
into the settlement.

     Sega Corporation ("Sega") initiated a claim for arbitration in Tokyo, Japan
against Diamond in December 1998. The claim arises out of an agreement entered
into between Sega and Diamond in September 1995, in which Sega agreed to provide
Diamond with Sega game software that Diamond would bundle with its 3-D graphics
board "The Edge." Sega claims that Diamond breached the parties' agreement by
failing to pay Sega a contractual minimum royalty fee for the games as set forth
in the agreement. Sega claims as damages $3.8 million in unpaid royalties and
pre-judgment interest. On May 28, 1999, Diamond responded to Sega's claims by
filing an answer in which it denied the material allegations of Sega's claims.
The parties have filed additional briefs in support of their claims and
defenses. An evidentiary hearing on this action has not yet been scheduled.
SONICblue contests the material allegations of Sega's claims. In addition,
SONICblue has pleaded that Sega's failure to provide it with 3-D optimized game
software on a timely basis adversely affected sales of The Edge. SONICblue
claims that these lost sales and profits should provide an offset to Sega's
claims in the arbitration and intends to defend the suit vigorously.

     C3 Sales, Inc. ("C3") filed suit against SONICblue on October 6, 1999 in
the Harris County (Houston), Texas District Court. The petition sought a
judicial declaration that a Sales Representative Agreement entered into between
C3 and SONICblue on May 19, 1999 was a valid contract that governed the
relationship between the two parties. On November 8, 1999, SONICblue answered
acknowledging that the May 19, 1999 agreement was a contract between the two
parties. C3 failed to respond to informal requests by SONICblue to dismiss the
declaratory relief action on grounds that no justiciable controversy existed
between the parties. On December 3, 1999, SONICblue filed a summary judgment
motion seeking judgment against C3 on the grounds that no issues of material
fact remain to be determined regarding the declaratory judgment sought by C3. C3
responded by filing an amended petition raising new matters. Specifically, C3's
new claims allege that the Sales Representative Agreement applies to Diamond
products, and that certain commissions due under the agreement have not been
paid. SONICblue intends to defend this action vigorously.

     On January 6, 2000, PhoneTel Communications, Inc. ("PhoneTel") filed a
complaint for patent infringement against a group of defendants, including
Diamond, in the United States District Court for the Northern District of Texas.
PhoneTel generally alleges that Diamond and the other defendants are infringing
its two patents by making, using, selling, offering to sell and/or importing
digital synthesizers, personal computers, sound cards, or console game systems.
PhoneTel does not specify which Diamond products allegedly infringe its patents.
SONICblue filed Diamond's answer to the complaint on March 28, 2000. SONICblue
believes it has meritorious defenses and intends to vigorously defend itself
against the allegations made in the complaint.

     The digital media, consumer appliance and home networking industries are
characterized by frequent litigation, including litigation regarding patent and
other intellectual property rights. SONICblue is party to various legal
proceedings that arise in the ordinary course of business. Although the ultimate
outcome of these matters is not presently determinable, management believes that
the resolution of all such pending matters will not have a material adverse
effect on SONICblue's financial position or results of operations.

                                        62
<PAGE>   65
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

13. OTHER OPERATING EXPENSE

     Other operating expense is as follows:

<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31,
                                                            -------------------------
                                                            2000     1999      1998
                                                            ----    ------    -------
                                                                 (IN THOUSANDS)
<S>                                                         <C>     <C>       <C>
Write-off of acquired technologies........................  $--     $6,700    $ 8,000
Impairment of long-lived assets...........................   --         --     27,226
                                                            ---     ------    -------
          Total...........................................  $--     $6,700    $35,226
                                                            ===     ======    =======
</TABLE>

     The Company recorded a non-recurring charge of $6.7 million related to the
purchase of Diamond on September 24, 1999. The value assigned to purchased
in-process research and development was determined through valuation techniques
generally used by appraisers in the high-technology industry and was immediately
expensed in the period of acquisition because technological feasibility had not
been established and no alternative use had been identified. The charge is
discussed in more detail in Note 2.

     In January 1998, the Company entered into a $40.0 million technology
exchange with Cirrus Logic, Inc. to obtain graphic functionality technologies.
As a result of the exchange, the Company acquired the technology covered by 10
graphic patents and 25 graphic patent applications, as well as cross-licensed
Cirrus Logic's remaining patents. Under the terms of the cross-licensing
provisions, the Company and Cirrus Logic have a perpetual license to each
other's graphic patents and additional licenses with respect to the other
party's patents for agreed upon periods of time. The Company wrote-off $8.0
million of the value of the acquired technologies that were not realizable based
on estimated cash flows from the sale of products currently sold by the Company.
The remaining $32.0 million intangible asset was being amortized to cost of
sales based on the estimated lives of the currently utilized core technologies,
which was generally five years, until the fourth quarter of 1998.

     During the fourth quarter of 1998, management reevaluated the carrying
value of the intangible assets recorded in connection with the technology
exchange and related to the patents obtained from Brooktree, as well as other
long-lived assets, including property and equipment. This revaluation was
necessitated by management's determination based on recent results of operations
that the future expected sales and cash flows for the Company's operations would
be substantially lower than had been previously expected by management. Expected
undiscounted future cash flows were not sufficient to recover the carrying value
of such assets. Accordingly, an impairment loss of $27.2 million, representing
the excess of the carrying value over the estimated fair value of the assets,
was recognized for write-downs of a substantial portion of the intangible
assets. The estimated fair value of the intangible assets was based on
management's best estimate of the patent portfolio based on a comparison to
other graphics technology portfolios in the marketplace. The Company determined
that no write-down of property and equipment was necessary at December 31, 1998
based on its estimate of the fair value of such assets. Due to technological
changes in the graphics marketplace, the Company concluded it should accelerate
its amortization of its remaining patent portfolio, of approximately $4.0
million, over the remaining estimated life of those technologies, which was two
years.

14. RESTRUCTURING EXPENSE

     In August 2000, the Company adopted a restructuring plan relating to the
shutdown of its Diamond Multimedia-branded add-in board business to reflect its
long term strategy and focus. Restructuring expenses of $6.7 million in 2000
related to the shutdown included write-off of intangibles ($4.4 million),
facilities closure expenses ($0.8 million) and personnel severance compensation
and related expenses ($1.5 million). As part of the restructuring, the Company
also wrote off $3.4 million of inventory, through cost of sales. At December 31,
2000, the reserve remaining for these items was $2.1 million, consisting of $1.3
million in

                                        63
<PAGE>   66
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

personnel severance compensation and related expenses, and $0.8 million in
facilities closure expenses. Aside from the original write-off of intangibles,
reductions in the reserve were the result of cash payments. The Company expects
the plan to be completed by the end of 2001.

     In July 1998, the Company implemented a restructuring plan, resulting in a
charge of $6.1 million, in order to align resources with a new business model
and to lower the Company's overall cost structure. In connection with the
restructuring, the Company reduced its headcount and consolidated facilities.
Severance and related benefits represented the reduction of approximately 70
employees by the end of the second quarter of 1999. The number of temporary
employees and contractors used by the Company was also reduced. The
restructuring expense included the write-off and write-down in carrying value of
equipment, which consisted primarily of workstations, personal computers and
furniture that are no longer utilized in the Company's operations. These assets
were written down to their estimated fair value less cost to sell. Facility
closure expenses were incurred as a result of the vacating of one of two leased
buildings at the Company's headquarters and include leasehold improvements,
furniture, fixtures and network costs. The Company completed its move in 1999.

15. EARNINGS PER SHARE

     When computing diluted earnings per share, the Company includes only
potential common shares that are dilutive. Exercise of approximately 17,204,000
options in 1999, 15,042,000 options in 1998 and the conversion of approximately
5,385,000 convertible securities in 1999 and 1998 are not assumed because the
result would have been anti-dilutive.

     The following table sets forth the computation of basic and diluted
earnings per share:

<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31,
                                                    ------------------------------------------
                                                       2000           1999            1998
                                                    -----------    -----------    ------------
                                                     (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                 <C>            <C>            <C>
NUMERATOR
Net Income (Loss)
  Basic...........................................   $312,828       $(30,780)      $(113,204)
  Interest expense of convertible notes (net of
     tax).........................................      3,864             --              --
                                                     --------       --------       ---------
  Diluted.........................................   $316,692       $(30,780)      $(113,204)
                                                     ========       ========       =========
DENOMINATOR
  Denominator for basic earnings per share........     90,390         59,244          51,078
  Common stock equivalents -- options and
     warrants.....................................      5,375             --              --
  Common stock equivalents -- convertible notes...      5,385             --              --
                                                     --------       --------       ---------
  Denominator for diluted earnings per share......    101,150         59,244          51,078
                                                     ========       ========       =========
Basic earnings per share..........................   $   3.46       $  (0.52)      $   (2.22)
Diluted earnings per share........................   $   3.13       $  (0.52)      $   (2.22)
</TABLE>

                                        64
<PAGE>   67
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

16. COMPREHENSIVE INCOME

     The following are the components of accumulated other comprehensive loss,
net of tax:

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                     --------------------------------
                                                       2000        1999        1998
                                                     ---------    -------    --------
                                                              (IN THOUSANDS)
<S>                                                  <C>          <C>        <C>
Unrealized gain (loss) on investments..............  $(191,197)   $   803    $ (2,329)
Foreign currency translation adjustments...........     (8,402)    (8,366)    (12,426)
                                                     ---------    -------    --------
  Accumulated other comprehensive loss.............  $(199,599)   $(7,563)   $(14,755)
                                                     =========    =======    ========
</TABLE>

     The following schedule of other comprehensive income (loss) shows the
after-tax current-period gain (loss) and the reclassification adjustment.

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31,
                                                       ------------------------------
                                                         2000        1999      1998
                                                       ---------    ------    -------
                                                               (IN THOUSANDS)
<S>                                                    <C>          <C>       <C>
Unrealized gain (loss) on investments
  Unrealized gain (loss) on available-for-sale
     securities......................................  $(196,096)   $3,076    $(5,967)
  Less: reclassification adjustment for (gain) loss
     realized in net income..........................      4,096        56        (28)
                                                       ---------    ------    -------
Net unrealized gain (loss) on investments............   (192,000)    3,132     (5,995)
Foreign currency translation adjustments.............        (36)    4,060      7,518
                                                       ---------    ------    -------
Other comprehensive income (loss)....................  $(192,036)   $7,192    $ 1,523
                                                       =========    ======    =======
</TABLE>

17. SUBSEQUENT EVENTS

     In January 2001, SONICblue completed the transfer of its graphics chips
assets to S3 Graphics Co., Ltd., a joint venture between VIA and a wholly owned
subsidiary of SONICblue. Pursuant to the joint venture agreement with VIA,
SONICblue received 13 million shares of SONICblue common stock as initial
payment, and the joint venture assumed liabilities relating to the graphics
chips business. Upon the occurrence of certain events described in the
investment agreement between SONICblue and VIA, SONICblue must pay specified
liquidated damages, subject to a maximum damages cap. Under the joint venture
agreement, SONICblue will also receive earn-out payments if the new venture
meets specified profitability goals.

     The Company, through its wholly owned subsidiary, owns all outstanding
shares of Class A common stock of the joint venture, which represents 50% of the
voting power of the joint venture with respect to the election of directors and
0.1% of the economic interest of the joint venture. The Company does not own a
majority of the voting stock; it cannot elect a majority of the Board of
Directors and by the contractual terms will share in 0.1% of the economic
results of the joint venture. As a result, because it does not control the joint
venture, the Company will account for its investment in the joint venture using
the equity method.

     At closing, SONICblue issued to a wholly owned subsidiary of VIA a warrant
to purchase up to 2 million shares of SONICblue common stock at an exercise
price of $10.00 per share, for an aggregate exercise price of $20 million. The
warrant expires on January 3, 2005, unless terminated earlier. The VIA
subsidiary is entitled to registration rights with respect to the shares
issuable upon exercise of the warrant and to certain other shares. The Company's
wholly owned subsidiary has granted VIA an option to purchase all of its shares
of Class A common stock of the joint venture for an aggregate purchase price of
$10 million at any time until exercised in full. The option also provides that
the Company's subsidiary may require VIA to purchase all of the Class A shares
at any time after the occurrence of certain events.

                                        65
<PAGE>   68
                             SONICBLUE INCORPORATED

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

     The pro forma unaudited results of operations for the years ended December
31, 2000 and 1999, assuming the disposition of the graphics chips assets and the
acquisition of Diamond had occurred as of January 1, 1999, follows:

<TABLE>
<CAPTION>
                                                           FOR THE YEAR ENDED
                                                              DECEMBER 31,
                                                         ----------------------
                                                           2000         1999
                                                         ---------    ---------
                                                             (IN THOUSANDS,
                                                         EXCEPT PER SHARE DATA)
<S>                                                      <C>          <C>
Revenues...............................................  $309,790     $488,654
Net income (loss)......................................  $276,783     $(90,721)
Net income (loss) per common share:
  Basic................................................  $   3.58     $  (1.96)
  Diluted..............................................  $   3.14     $  (1.96)
</TABLE>

     In February 2001, SONICblue announced that it signed a definitive agreement
to acquire Sensory Science Corporation, whose assets include the Go Video,
California Audio Labs and Rave brands, as well as an exclusive distribution
agreement with Loewe Opta GmbH of Germany. Pending the consummation of the
acquisition of Sensory Science Corporation, SONICblue has made a loan to Sensory
Science in the amount of $3 million and has obtained a warrant to purchase
5,357,143 shares of Sensory Science common stock.

     In March 2001, SONICblue signed a definitive agreement to acquire ReplayTV,
Inc., a developer of personal television technology. Under the terms of the
agreement, SONICblue will issue an aggregate of 15.5 million shares of common
stock and options and warrants to purchase shares of SONICblue common stock in
exchange for all of ReplayTV's outstanding equity interests, and ReplayTV will
become a wholly owned subsidiary of SONICblue. The agreement also provides that
if the value of the SONICblue common stock to be issued to stockholders of
ReplayTV at the closing of the transaction is less than $80 million, ReplayTV
may terminate the agreement unless SONICblue, at its option, either pays
additional cash or issues additional shares to bring the value at closing to $80
million. In connection with the proposed acquisition of ReplayTV, SONICblue has
made loans to Replay in the amount of $10 million and agreed to loan ReplayTV up
to an additional $6 million.

     In March 2001, SONICblue announced the proposed sale to ATI Technologies of
its professional graphics division, based in Starnberg, Germany, which produces
the Fire GL line of graphics accelerators. Under the terms of an Asset Purchase
Agreement, SONICblue will receive $2.7 million in cash and is eligible to
receive further financial consideration of up to $7.3 million, contingent upon
the Fire GL graphics business achieving future performance targets.

                                        66
<PAGE>   69

SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)

     The following table presents selected unaudited consolidated financial
results for each of the eight quarters in the two-year period ended December 31,
2000. In the Company's opinion, this unaudited information has been prepared on
the same basis as the audited information and includes all adjustments
(consisting of only normal recurring adjustments) necessary for a fair statement
of the financial information for the period presented.

<TABLE>
<CAPTION>
                                                   FOURTH       THIRD        SECOND      FIRST
                                                  QUARTER     QUARTER(1)    QUARTER     QUARTER
                                                  --------    ----------    --------    --------
                                                     (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                               <C>         <C>           <C>         <C>
YEAR ENDED DECEMBER 31, 2000
Net sales.......................................  $ 99,205     $139,960     $135,820    $161,719
Gross margin (loss).............................    (6,668)     (23,652)       5,004      13,404
Income (loss) from operations(2)................   (77,362)     (93,713)     (54,815)    (47,441)
Net income (loss)(3)............................   (67,509)     (75,648)     (36,258)    492,243
Per share amounts:
  Basic.........................................  $  (0.72)    $  (0.82)    $  (0.40)   $   5.84
  Diluted(4)....................................  $  (0.72)    $  (0.82)    $  (0.40)   $   5.04
Shares used in computing per share amounts:
  Basic.........................................    93,313       92,573       91,402      84,272
  Diluted(4)....................................    93,313       92,573       91,402      97,864
YEAR ENDED DECEMBER 31, 1999
Net sales.......................................  $180,546     $ 70,484     $ 57,253    $ 44,300
Gross margin (loss).............................     2,930       15,688       16,537      10,267
Income (loss) from operations(2)................   (56,765)     (18,383)      (9,456)    (15,558)
Net income (loss)(3)............................    (6,903)     (11,098)       1,100     (13,879)
Per share amounts:
  Basic.........................................  $  (0.09)    $  (0.20)    $   0.02    $  (0.27)
  Diluted(4)....................................  $  (0.09)    $  (0.20)    $   0.02    $  (0.27)
Shares used in computing per share amounts:
  Basic.........................................    77,121       55,419       53,164      51,856
  Diluted(4)....................................    77,121       55,419       57,588      51,856
</TABLE>

---------------
(1) Gross margin (loss) for the third quarter of 2000 was restated from the
    amounts presented in the Quarterly Report on Form 10-Q for the period ended
    September 30, 2000 to reflect the reclassification of an inventory writedown
    which was previously classified as restructuring expense. The
    reclassification had no impact on income (loss) from operations and net
    income (loss).

(2) Loss from operations for 2000 includes a $10.1 million restructuring charge.
    Loss from operations for 1999 includes a write-off of acquired technologies
    of $6.7 million in the fourth quarter of 1999.

(3) Net income (loss) includes gain on sale of joint venture of $7.2 million in
    the second quarter of 1999, $7.5 million in the third quarter of 1999, $7.8
    million in the fourth quarter of 1999, $7.5 million in the first quarter of
    2000 and $7.2 million in the second quarter of 2000.

(4) Diluted earnings per share includes the effect of incremental shares
    issuable upon the conversion of the convertible subordinated notes, the
    dilutive effect of outstanding options and an adjustment to net income for
    the interest expense (net of income taxes) related to the notes unless the
    impact of such conversion is anti-dilutive. The effect of the conversion was
    anti-dilutive all quarters of 2000 and 1999, except for the first quarter of
    2000.

                                        67
<PAGE>   70

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

     Not applicable

                                    PART III

     Certain information required by Part III is incorporated by reference from
the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the solicitation of proxies for the
Company's 2001 Annual Meeting of Stockholders (the "Proxy Statement") to be held
on May 23, 2001.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

     The information required by this section (with respect to directors) is
incorporated by reference from the information in the section entitled "Proposal
1 -- Election of Directors" in the Proxy Statement.

     Item 405 of Regulation S-K calls for disclosure of any known late filing or
failure by an insider to file a report required by Section 16 of the Exchange
Act. This disclosure is contained in the section entitled "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Proxy Statement and is
incorporated herein by reference.

     The executive officers of the Company are as follows:

     Kenneth F. Potashner, age 43, has served as Chief Executive Officer,
President and Chairman of the Board of SONICblue since November 1998. Mr.
Potashner has been a director of Maxwell Technologies, Inc. since April 1996 and
became Chairman of the Board of Maxwell Technologies in April 1997. From the
time he joined Maxwell Technologies in April 1996 until October 1998, Mr.
Potashner served as the President, Chief Executive Officer and Chief Operating
Officer. From 1994 to April of 1996, he served as Executive Vice President,
Operations, for Conner Peripherals, Inc. From 1991 through 1994, Mr. Potashner
was Vice President, Product Engineering, for Quantum Corporation. Mr. Potashner
is also a member of the Board of Directors of Newport Corporation.

     Paul G. Franklin, age 57, is Senior Vice President, Business Development,
and joined SONICblue in September 1992. From March 1991 to September 1992 he was
a consultant to SONICblue. Mr. Franklin was a consultant for a number of
semiconductor companies from January 1990 through March 1991. From March 1986 to
December 1989, Mr. Franklin was Vice President of Operations of Actel
Corporation, a supplier of field programmable gate arrays. Prior to 1986, Mr.
Franklin held various management positions at Monolithic Memories Inc., a
supplier of semiconductor memories and programmable logic.

     William F. McFarland, age 49, joined SONICblue in January 2000 as Vice
President and Controller. He became Interim Chief Financial Officer in August
2000. From January 1988 to December 1999, Mr. McFarland served in a variety of
finance and information technology management positions at SGI, Inc., a provider
of high-performance computing and visualization solutions for technical and
creative users. From September 1985 to December 1987, Mr. McFarland served as
Tax Director of Spectra-Physics, Inc., a manufacturer of laser systems.

     Andrew L. Wolfe, age 38, joined SONICblue in June 1997 and became Chief
Technical Officer in May 1999. From September 1991 to 1997 he was an Assistant
Professor at Princeton University where he taught Electrical Engineering.

     Richard Burns, age 46, joined SONICblue in March 2001 as Vice President,
Worldwide Sales. From March 1999 to March 2001 he was Senior Vice President,
Worldwide Sales at 3DFX Interactive, a supplier of graphics chips for personal
computers. From September 1998 to March 1999 he worked as a consultant for
Disney Interactive. From December 1995 to May 1998 he served as Executive Vice
President, Domestic Publishing for GT Interactive Software, a game software
publisher.

                                        68
<PAGE>   71

ITEM 11. EXECUTIVE COMPENSATION.

     The information required by this section is incorporated by reference from
the information in the sections entitled "Directors' Compensation" and
"Executive Compensation" in the Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

     The information required by this section is incorporated by reference from
the information in the section entitled "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     The information required by this section is incorporated by reference from
the information in the section entitled "Certain Relationships and Related Party
Transactions" in the Proxy Statement.

                                    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 Form 10-K:

     (1) Financial Statements:

          Reference is made to the Index to Consolidated Financial Statements of
     SONICblue Incorporated under Item 8 in Part II of this Form 10-K.

     (2) Financial Statement Schedules:

          The following financial statement schedule of SONICblue Incorporated
     for the years ended December 31, 2000, 1999 and 1998 is filed as part of
     this Report and should be read in conjunction with the Consolidated
     Financial Statements of SONICblue Incorporated.

<TABLE>
<CAPTION>
                                                              REFERENCE
                                                                PAGE
                                                              ---------
<S>                                                           <C>
Schedule II -- Valuation and Qualifying Accounts............     72
</TABLE>

          All other schedules are omitted because they are not applicable or the
     required information is shown in the financial statements or notes thereto.

     (3) Exhibits:

          The exhibits listed below are required by Item 601 of Regulation S-K.
     Each management contract or compensatory plan or arrangement required to be
     filed as an exhibit to this Form 10-K has been identified.

<TABLE>
<CAPTION>
EXHIBIT
NUMBER   NOTES                     DESCRIPTION OF DOCUMENT
-------  -----                     -----------------------
<S>      <C>     <C>
 3(i)#           Restated Certificate of Incorporation.
 3(ii)    (9)    Amended and Restated Bylaws.
 4.1      (1)    Specimen common stock certificate.
 4.2      (7)    Indenture, dated as of September 12, 1996 between Registrant
                 and State Street Bank and Trust Company of California, N.A.,
                 as Trustee, including form of Note.
 4.3      (8)    Rights Agreement dated as of May 14, 1997 between S3
                 Incorporated and The First National Bank of Boston, Rights
                 Agent.
10.1*    (11)    1989 Stock Plan of S3 Incorporated, as amended (the "1989
                 Plan").
10.2*     (1)    Form of Incentive Stock Option Agreement under the 1989
                 Plan.
10.3*     (1)    Form of common stock Purchase Agreement under the 1989 Plan.
10.4*     (2)    S3 Incorporated 1993 Employee Stock Purchase Plan.
</TABLE>

                                        69
<PAGE>   72

<TABLE>
<CAPTION>
EXHIBIT
NUMBER   NOTES                     DESCRIPTION OF DOCUMENT
-------  -----                     -----------------------
<S>      <C>     <C>
10.5*    (14)    1992 Stock Plan of Diamond Multimedia Systems, Inc.
                 ("Diamond") and form of Stock Option Agreement.
10.6*    (14)    1994 Stock Plan of Diamond and form of Stock Option
                 Agreement.
10.7*    (14)    1995 Director Option Plan of Diamond and form of Stock
                 Option Agreement.
10.8*    (15)    1998 Stock Plan of Diamond and form of Stock Option
                 Agreement.
10.9      (1)    Form of Indemnification Agreement between the Registrant and
                 its directors.
10.10     (6)    Lease between Mission Real Estate, L.P. and Registrant dated
                 November 29, 1995.
10.11     (3)    Office Lease dated May 13, 1993, between the Registrant and
                 San Tomas No. 2 Limited Partnership.
10.12     (3)    First Amendment of Office Lease dated September 9, 1993,
                 between the Registrant and San Tomas No. 2 Limited
                 Partnership.
10.13+    (5)    Foundry Venture Agreement among Registrant, Alliance
                 Semiconductor Corporation and United Microelectronics
                 Corporation dated as of July 8, 1995.
10.14     (4)    Office Lease dated March 30, 1994, between the Registrant
                 and San Tomas No. 1 Limited Partnership.
10.15     (4)    Second Amendment of Office Lease dated March 30, 1994,
                 between the Registrant and San Tomas No. 2 Limited
                 Partnership.
10.16    (14)    Lease dated November 19, 1999, between Diamond and Montague
                 LLC.
10.17    (14)    Lease dated December 26, 1995, between NL Properties, Inc.
                 and Diamond.
10.18    (16)    Sublease dated May 12, 1998 between Reed Elsevier, Inc. and
                 Diamond.
10.19*   (10)    Employment Agreement between Registrant and Terry N. Holdt
                 dated December 18, 1997.
10.20*   (12)    Employment Agreement between Registrant and Kenneth F.
                 Potashner, dated October 30, 1998.
10.21*   (13)    Involuntary Termination Agreement between Registrant and
                 Paul G. Franklin, dated September 22, 1998.
10.22*   (17)    Involuntary Termination Agreement between Registrant and
                 Andy Wolfe, dated September 22, 1998.
10.23#           Form of Promissory Note and Security Agreement between each
                 of Messrs. Lee, Holdt, Santoro and Schraith and SONICblue
                 Incorporated.
10.24#           Form of Promissory Note and Security Agreement between each
                 of Messrs. Lee, Holdt, Santoro and Schraith and SONICblue
                 Incorporated.
21.1#            Significant Subsidiaries of Registrant.
23.1#            Consent of Ernst and Young LLP, Independent Auditors (San
                 Jose, California).
24.1#            Power of Attorney (see page 73 of this Form 10-K).
</TABLE>

---------------
  #  Filed herewith.

  *  Indicates management contract or compensatory plan or arrangement.

  +  Confidential treatment has been granted with respect to certain portions of
this agreement.

 (1) Incorporated by reference to the Registrant's Registration Statement on
     Form S-1 (File No. 33-57114).

 (2) Incorporated by reference to Exhibit 10.15 to the Registrant's Registration
     Statement on Form S-8 (File No. 33-65186).

 (3) Incorporated by reference to the exhibit of the same number to the
     Registrant's Annual Report on Form 10-K for the year ended December 31,
     1993.

 (4) Incorporated by reference to the exhibit of the same number to the
     Registrant's Annual Report on Form 10-K for the year ended December 31,
     1994.

 (5) Incorporated by reference to the exhibit of the same number to the
     Registrant's Current Report on Form 8-K filed July 25, 1995.

 (6) Incorporated by reference to Exhibit 10.14 to the Registrant's Annual
     Report on Form 10-K for the year ended December 31, 1995.

                                        70
<PAGE>   73

 (7) Incorporated by reference to Exhibit 4.1 to Registrant's Quarterly Report
     on Form 10-Q for the quarter ended September 30, 1996.

 (8) Incorporated by reference to Exhibit 4.4 to Registrant's Quarterly Report
     on Form 10-Q for the quarter ended September 30, 1996.

 (9) Incorporated by reference to the exhibit of the same number to Registrant's
     Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.

(10) Incorporated by reference to Exhibit 10.14 to the Registrant's Annual
     Report on Form 10-K for the year ended December 31, 1997.

(11) Incorporated by reference to Exhibit 10.1 to the Registrant's Annual Report
     on Form 10-K for the year ended December 31, 1997.

(12) Incorporated by reference to Exhibit 10.13 to the Registrant's Annual
     Report on Form 10-K for the year ended December 31, 1998.

(13) Incorporated by reference to Exhibit 10.15 to the Registrant's Annual
     Report on Form 10-K for the year ended December 31, 1998.

(14) Incorporated by reference to Diamond's Registration Statement on Form S-1
     (File No. 33-89386).

(15) Incorporated by reference to Diamond's Registration Statement on Form S-8
     (File No. 333-61147).

(16) Incorporated by reference to Exhibit 10.17 Diamond's Annual Report on Form
     10-K for the year ended December 31, 1998.

(17) Incorporated by reference to Exhibit 10.24 to the Registrant's Annual
     Report on Form 10-K for the year ended December 31, 2000.

(b) Reports on Form 8-K:

     The Company did not file any reports on Form 8-K during the three months
ended December 31, 2000.

                                        71
<PAGE>   74

                                                                     SCHEDULE II

                       VALUATION AND QUALIFYING ACCOUNTS

                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                    BALANCE AT    CHARGED TO    REVERSALS TO                    BALANCE AT
                                    BEGINNING     COSTS AND      COSTS AND                        END OF
           DESCRIPTION              OF PERIOD      EXPENSES       EXPENSES      (DEDUCTIONS)      PERIOD
           -----------              ----------    ----------    ------------    ------------    ----------
<S>                                 <C>           <C>           <C>             <C>             <C>
Allowance for doubtful accounts:
  2000............................   $ 3,562       $ 1,857        $   (438)       $(1,680)       $ 3,301
  1999............................     2,296         2,699            (384)        (1,049)         3,562
  1998............................     1,507           600              --             89          2,296
Sales returns and allowances:
  2000............................   $15,736       $ 6,751        $(16,860)       $(1,138)       $ 4,489
  1999............................     4,229        24,950         (10,665)        (2,678)        15,736
  1998............................     4,157         1,453            (631)          (750)         4,229
</TABLE>

                                        72
<PAGE>   75

                                   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 to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 31, 2001.

                                          SONICblue INCORPORATED
                                          (Registrant)

                                          By:   /s/ KENNETH F. POTASHNER
                                            ------------------------------------
                                                    Kenneth F. Potashner
                                                         President
                                                  Chief Executive Officer
                                                   Chairman of the Board

                               POWER OF ATTORNEY

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Kenneth F. Potashner, William F.
McFarland, and Terry Holdt, and each of them, his or her true and lawful
attorneys-in-fact, each with full power of substitution, for him or her in any
and all capacities, to sign any 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 each of said attorneys-in-fact or their substitute or
substitutes may do or cause to be done by virtue hereof.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated:

<TABLE>
<CAPTION>
                      SIGNATURE                                     TITLE                    DATE
                      ---------                                     -----                    ----
<S>                                                    <C>                              <C>
              /s/ KENNETH F. POTASHNER                   President, Chief Executive     March 31, 2001
-----------------------------------------------------   Officer Chairman of the Board
                Kenneth F. Potashner

              /s/ WILLIAM F. MCFARLAND                  Vice President, Controller &     April 2, 2001
-----------------------------------------------------  Interim Chief Financial Officer
                William F. McFarland                      (Principal Financial and
                                                             Accounting Officer)

                 /s/ TERRY N. HOLDT                      Vice Chairman of the Board     March 31, 2001
-----------------------------------------------------
                   Terry N. Holdt

                  /s/ ROBERT P. LEE                               Director              March 31, 2001
-----------------------------------------------------
                    Robert P. Lee

               /s/ CARMELO J. SANTORO                             Director              March 30, 2001
-----------------------------------------------------
                 Carmelo J. Santoro

                /s/ JAMES T. SCHRAITH                             Director               April 2, 2001
-----------------------------------------------------
                  James T. Schraith
</TABLE>

                                        73
<PAGE>   76

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER    NOTES                     DESCRIPTION OF DOCUMENT
-------   -----                     -----------------------
<S>       <C>     <C>
 3(i)#            Restated Certificate of Incorporation.
 3(ii)     (9)    Amended and Restated Bylaws.
 4.1       (1)    Specimen common stock certificate.
 4.2       (7)    Indenture, dated as of September 12, 1996 between Registrant
                  and State Street Bank and Trust Company of California, N.A.,
                  as Trustee, including form of Note.
 4.3       (8)    Rights Agreement dated as of May 14, 1997 between S3
                  Incorporated and The First National Bank of Boston, Rights
                  Agent.
10.1*     (11)    1989 Stock Plan of S3 Incorporated, as amended (the "1989
                  Plan").
10.2*      (1)    Form of Incentive Stock Option Agreement under the 1989
                  Plan.
10.3*      (1)    Form of common stock Purchase Agreement under the 1989 Plan.
10.4*      (2)    S3 Incorporated 1993 Employee Stock Purchase Plan.
10.5*     (14)    1992 Stock Plan of Diamond Multimedia Systems, Inc.
                  ("Diamond") and form of Stock Option Agreement.
10.6*     (14)    1994 Stock Plan of Diamond and form of Stock Option
                  Agreement.
10.7*     (14)    1995 Director Option Plan of Diamond and form of Stock
                  Option Agreement.
10.8*     (15)    1998 Stock Plan of Diamond and form of Stock Option
                  Agreement.
10.9       (1)    Form of Indemnification Agreement between the Registrant and
                  its directors.
10.10      (6)    Lease between Mission Real Estate, L.P. and Registrant dated
                  November 29, 1995.
10.11      (3)    Office Lease dated May 13, 1993, between the Registrant and
                  San Tomas No. 2 Limited Partnership.
10.12      (3)    First Amendment of Office Lease dated September 9, 1993,
                  between the Registrant and San Tomas No. 2 Limited
                  Partnership.
10.13+     (5)    Foundry Venture Agreement among Registrant, Alliance
                  Semiconductor Corporation and United Microelectronics
                  Corporation dated as of July 8, 1995.
10.14      (4)    Office Lease dated March 30, 1994, between the Registrant
                  and San Tomas No. 1 Limited Partnership.
10.15      (4)    Second Amendment of Office Lease dated March 30, 1994,
                  between the Registrant and San Tomas No. 2 Limited
                  Partnership.
10.16     (14)    Lease dated November 19, 1999, between Diamond and Montague
                  LLC.
10.17     (14)    Lease dated December 26, 1995, between NL Properties, Inc.
                  and Diamond.
10.18     (16)    Sublease dated May 12, 1998 between Reed Elsevier, Inc. and
                  Diamond.
10.19*    (10)    Employment Agreement between Registrant and Terry N. Holdt
                  dated December 18, 1997.
10.20*    (12)    Employment Agreement between Registrant and Kenneth F.
                  Potashner, dated October 30, 1998.
10.21*    (13)    Involuntary Termination Agreement between Registrant and
                  Paul G. Franklin, dated September 22, 1998.
10.22*    (17)    Involuntary Termination Agreement between Registrant and
                  Andy Wolfe, dated September 22, 1998.
10.23#            Form of Promissory Note and Security Agreement between each
                  of Messrs. Lee, Holdt, Santoro and Schraith and SONICblue
                  Incorporated.
10.24#            Form of Promissory Note and Security Agreement between each
                  of Messrs. Lee, Holdt, Santoro and Schraith and SONICblue
                  Incorporated.
21.1#             Significant subsidiaries of Registrant.
23.1#             Consent of Ernst and Young LLP, Independent Auditors (San
                  Jose, California).
24.1#             Power of Attorney (see page 73 of this Form 10-K).
</TABLE>

---------------

<TABLE>
<C>   <S>
   #  Filed herewith.
   *  Indicates management contract or compensatory plan or
      arrangement.
</TABLE>

                                        74
<PAGE>   77
<TABLE>
<C>   <S>
   +  Confidential treatment has been granted with respect to
      certain portions of this agreement.
 (1)  Incorporated by reference to the Registrant's Registration
      Statement on Form S-1 (File No. 33-57114).
 (2)  Incorporated by reference to Exhibit 10.15 to the
      Registrant's Registration Statement on Form S-8 (File No.
      33-65186).
 (3)  Incorporated by reference to the exhibit of the same number
      to the Registrant's Annual Report on Form 10-K for the year
      ended December 31, 1993.
 (4)  Incorporated by reference to the exhibit of the same number
      to the Registrant's Annual Report on Form 10-K for the year
      ended December 31, 1994.
 (5)  Incorporated by reference to the exhibit of the same number
      to the Registrant's Current Report on Form 8-K filed July
      25, 1995.
 (6)  Incorporated by reference to Exhibit 10.14 to the
      Registrant's Annual Report on Form 10-K for the year ended
      December 31, 1995.
 (7)  Incorporated by reference to Exhibit 4.1 to Registrant's
      Quarterly Report on Form 10-Q for the quarter ended
      September 30, 1996.
 (8)  Incorporated by reference to Exhibit 4.4 to Registrant's
      Quarterly Report on Form 10-Q for the quarter ended
      September 30, 1996.
 (9)  Incorporated by reference to the exhibit of the same number
      to Registrant's Quarterly Report on Form 10-Q for the
      quarter ended June 30, 1997.
(10)  Incorporated by reference to Exhibit 10.14 to the
      Registrant's Annual Report on Form 10-K for the year ended
      December 31, 1997.
(11)  Incorporated by reference to Exhibit 10.1 to the
      Registrant's Annual Report on Form 10-K for the year ended
      December 31, 1997.
(12)  Incorporated by reference to Exhibit 10.13 to the
      Registrant's Annual Report on Form 10-K for the year ended
      December 31, 1998.
(13)  Incorporated by reference to Exhibit 10.15 to the
      Registrant's Annual Report on Form 10-K for the year ended
      December 31, 1998.
(14)  Incorporated by reference to Diamond's Registration
      Statement on Form S-1 (File No. 33-89386).
(15)  Incorporated by reference to Diamond's Registration
      Statement on Form S-8 (File No. 333-61147).
(16)  Incorporated by reference to Exhibit 10.17 Diamond's Annual
      Report on Form 10-K for the year ended December 31, 1998.
(17)  Incorporated by reference to Exhibit 10.24 to the
      Registrant's Annual Report on Form 10-K for the year ended
      December 31, 2000.
</TABLE>

                                        75