<PAGE>

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                   FORM 10-Q

(Mark One)

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
    Exchange Act of 1934 for the quarterly period 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 No. 333-64483


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


              Delaware                                   94-3226532
    (State or other jurisdiction of                    (IRS Employer
    Incorporation or organization)                 Identification Number)

                               800 Saginaw Drive
                             Redwood City, CA 94063
                    (Address of principal executive offices)

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

     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.  [X] Yes  [ ] No


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

            Title of each class
            -------------------
        Common Stock, $.001 par value                 18,138,187
        Class C Common Stock, $.001 par value            857,370
<PAGE>

                           DIVA SYSTEMS CORPORATION

                         Quarterly Report on Form 10-Q

                               Table of Contents

                        Quarter Ended December 31, 2000



                         PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
<S>            <C>                                                                        <C>
Item 1.        Consolidated Financial Statements (Unaudited)
                  Condensed Consolidated Balance Sheet at December 31, 2000 and
                  June 30, 2000                                                              1
                  Condensed Consolidated Statement of Operations for the three months
                  and six months ended December 31, 2000 and 1999                            2
                  Condensed Consolidated Statement of Cash Flows for the six months
                  ended December 31, 2000 and 1999                                           3
                  Notes to Condensed Consolidated Financial Statements                       5
Item 2.        Management's Discussion and Analysis of Financial Condition and
                  Results of Operations                                                      6
Item 3.        Quantitative and Qualitative disclosures about Market Risk                   13
</TABLE>

                          PART II - OTHER INFORMATION
<TABLE>
<CAPTION>

<S>            <C>                                                                         <C>
Item 2.        Changes in Securities and Use of Proceeds                                    26
Item 6.        Exhibits and Reports on Form 8-K                                             26
Signatures                                                                                  27
</TABLE>
<PAGE>

                                     PART I

ITEM 1.  FINANCIAL STATEMENTS

                   DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
                     Condensed Consolidated Balance Sheets
                     (in thousands, except per share data)
                                  (unaudited)
<TABLE>
<CAPTION>

                                                                                      December 31,        June 30,
                                                                                         2000              2000
                                                                                   ----------------    -------------
<S>                                                                                <C>                 <C>
                                Assets
Current assets:
    Cash and cash equivalents                                                    $         38,783    $      66,253
    Short-term investments                                                                 37,976           26,429
    Accounts receivable                                                                     1,562              264
    Inventory                                                                              15,080            3,143
    Prepaid expenses and other current assets                                                 724            3,520
                                                                                   ----------------    -------------

          Total current assets                                                             94,125           99,609

Property and equipment, net                                                                11,493           12,648
Debt issuance costs, net                                                                    5,607            6,500
Deposits and other assets                                                                     583              596
Intangible assets, net                                                                         44              134
                                                                                   ----------------    -------------

          Total assets                                                           $        111,852     $    119,487
                                                                                  =================    =============
        Liabilities, Redeemable Warrants and Stockholders' Deficit

Current liabilities:
    Accounts payable                                                             $          6,351     $      5,121
    Other current liabilities                                                               2,624            4,441
    Deferred revenue                                                                          965            1,015
    Current portion of capital lease obligation                                               706              676
                                                                                   ----------------    -------------
          Total current liabilities                                                        10,646           11,253

Notes payable                                                                             333,440          312,815
Redeemable put warrants                                                                     7,326           11,989
Long - term portion of lease payable                                                          668            1,029
Deferred rent                                                                                 839              780
                                                                                   ----------------    -------------
          Total liabilities                                                               352,919          337,866
                                                                                   ----------------    -------------
Redeemable warrants                                                                         4,856            7,007
                                                                                   ----------------    -------------
Commitments and contingencies

Stockholders' deficit:
    Preferred stock, $0.001 par value; 80,000,000 shares authorized;
       25,120,253 and 24,495,463 shares issued and outstanding as of
       December 31, 2000, and June 30, 2000, respectively.                                     25               24
    Common stock, $0.001 par value; 165,000,000 shares authorized;
       18,880,321 and 18,615,618 shares issued and outstanding as of
       December 31, 2000, and June 30, 2000,  respectively.                                    19               19

Additional paid-in capital                                                                148,426          138,211
Deferred compensation                                                                      (6,242)          (5,954)
Accumulated deficit                                                                      (388,151)        (357,686)
                                                                                   ----------------    -------------
          Total stockholders' deficit                                                    (245,923)        (225,386)
                                                                                   ----------------    -------------

          Total liabilities, redeemable warrants and
          stockholders' deficit                                                  $        111,852    $     119,487
                                                                                   ================    =============
</TABLE>

See accompanying notes to interim condensed consolidated financial statements.

                                       1
<PAGE>

                   DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
                Condensed Consolidated Statements of Operations
                     (in thousands, except per share data)
                                  (unaudited)
<TABLE>
<CAPTION>


                                                                 Three Months Ended                Six Months Ended
                                                                    December 31,                      December 31,
                                                              2000              1999             2000             1999
                                                          -----------        ----------       ----------       ----------
<S>                                                       <C>                <C>              <C>              <C>
Revenues:
          Product                                        $        18        $     944        $       53       $     944
          License                                                 45               --                81              --
          Service                                              1,030              103             1,344             171
                                                          -----------        ----------       ----------       ----------
                 Total revenues                                1,093            1,047             1,478           1,115

Operating expenses:
          Cost of product revenue                                553            1,103               738           1,103
          Programming                                            878            1,023             1,925           2,265
          Operations                                           1,772            1,529             3,588           3,000
          Engineering and development                          7,678            6,922            15,690          12,203
          Sales and marketing                                  1,793            1,680             3,265           3,293
          General and administrative                           6,117            4,068            11,621           8,758
          Depreciation and amortization                        1,511            1,801             3,033           3,275
          Warrant expense                                        247              --                 66             --
          Amortization of stock compensation                   1,092              180             2,220             385
                                                          -----------        ----------       ----------       ----------
                 Total operating expenses                     21,641           18,306            42,146          34,282
                                                          -----------        ----------       ----------       ----------
                 Operating loss                               20,548           17,259            40,668          33,167
                                                          -----------        ----------       ----------       ----------
Other (income) expense:
          Interest income                                     (1,396)          (1,514)           (2,067)         (3,099)
          Gain on sale of investments                        (11,524)             --            (24,421)            --
          Gain on sale of property and equipment                 --               --                (40)            --
          Interest expense                                    11,030            9,631            16,325          18,817
                                                          -----------        ----------       ----------       ----------
                 Total other (income)expense, net             (1,890)           8,117           (10,203)         15,718
                                                          -----------        ----------       ----------       ----------

                 Net loss                                     18,658           25,376            30,465          48,885

Accretion of redeemable warrants                                 254              152            (2,150)            304
                                                          -----------        ----------       ----------       ----------

                 Net loss attributable to
                      common stockholders                $    18,912       $   25,528        $   28,315       $  49,189
                                                          ===========        ==========       ==========       ==========

Basic and diluted net loss per share:                    $      1.01       $     1.44        $     1.51       $    2.79
                                                          ===========        ==========       ==========       ==========

Shares used in per share computation                          18,796           17,689            18,744          17,600
                                                          ===========        ==========       ==========       ==========
</TABLE>

See accompanying notes to interim condensed consolidated financial statements.

                                       2
<PAGE>

                   DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
                 Condensed Consolidated Statement of Cash Flows
                                 (in thousands)
                                  (unaudited)
<TABLE>
<CAPTION>
                                                                                   Six Months Ended
                                                                                     December 31,
                                                                              2000                 1999
                                                                          ------------          -----------
<S>                                                                       <C>                   <C>
Cash flows from operating activities:
  Net loss                                                               $   (30,465)          $   (48,885)
  Adjustments to reconcile net loss to net
    cash used in operating activities:
      Depreciation and amortization                                            3,033                 3,275
      (Gain)/loss on disposition of property and                                 (40)                   74
         equipment
      Amortization of debt issuance costs and
         accretion of discount on notes payable                               16,855                18,790
      Amortization of deferred stock compensation                              2,220                   385
      Warrant expense                                                             66                   --
      Gain on disposal of investments                                        (24,421)                  --
      Changes in operating assets and liabilities:
             Other assets                                                        798                 1,388
             Accounts receivable                                                 700                   --
             Inventory                                                       (11,937)                  256
             Accounts payable                                                  1,230                  (669)
             Other current liabilities                                           (50)                  453
             Deferred rent                                                      (112)                  --
             Deferred revenue                                                 (1,817)                  731
                                                                          ------------          -----------
                  Net cash used for operating activities                     (43,940)              (24,202)
                                                                          ------------          -----------
Cash flows from investing activities:
  Purchases of property and equipment                                         (1,861)               (3,831)
  Proceeds from sale of investments                                           24,421                    --
  Proceeds from the sale of assets                                               125                    --
  Purchases of short-term investments                                        (11,547)              (15,764)
                                                                          ------------          -----------
                  Net cash provided by (used for) investing activities        11,138               (19,595)
                                                                          ------------          -----------
Cash flows from financing activities:
  Issuance of preferred stock, net                                             5,000                 7,000
  Exercise of stock options                                                      492                   563
  Payments on capital lease                                                     (160)                  (87)
  Payments on note payable                                                        --                   (11)
                                                                          ------------          -----------
                  Net cash provided by financing activities                    5,332                 7,465
                                                                          ------------          -----------
Net decrease in cash and cash equivalents                                    (27,470)              (36,332)

Cash and cash equivalents at beginning of period                              66,253                89,239
                                                                          ------------          -----------
Cash and cash equivalents at end of period                               $    38,783           $    52,907
                                                                          ============          ===========
</TABLE>

                                       3
<PAGE>

                   DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
          Condensed Consolidated Statement of Cash Flows (Continued)
                                (in thousands)
                                  (unaudited)

<TABLE>
<S>                                                           <C>
        Noncash investing and financing activities:
        Reclassification of equipment to inventory            $               --   $              307
                                                               =================     ================
        Equipment acquired under capital lease obligations    $               --   $            1,576
                                                               =================     ================
        (Decrement)/Accretion of redeemable warrants          $           (2,150)  $              304
                                                               =================     ================

See accompanying notes to interim condensed consolidated financial statements.

</TABLE>

                                       4
<PAGE>

                   DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
          NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

Note 1-The Company And Basis Of Presentation

     DIVA Systems Corporation (the "Company"), is a provider of interactive,
video-on-demand products and services.  The Company was in the development stage
from July 1, 1995 (inception) to September 30, 1999, and its primary activities
were performing research and development, licensing program content,
manufacturing the necessary equipment, developing a service offering,
establishing strategic alliances, deploying service trials and limited
commercial launches with cable operators, and raising capital to finance these
activities.   As of October 1, 1999, the Company commenced principal operations,
which consists of manufacturing, selling, licensing and providing operational
support for its video-on-demand products and services.

     The interim unaudited financial statements as of December 31, 2000, and for
the three and six months ended December 31, 2000 and 1999 have been prepared on
substantially the same basis as the Company's audited financial statements for
the year ended June 30, 2000 and include all adjustments, consisting only of
normal recurring adjustments, that, in the opinion of management, are necessary
for a fair presentation of the financial information set forth herein.  The
results of operations for current interim periods are not necessarily indicative
of results to be expected for the current year or any other period.

     These interim unaudited financial statements should be read in conjunction
with the Company's annual financial statements, included in the Company's Form
10-K for the year ended June 30, 2000 (Fiscal 2000).

Note 2-Basic and Diluted Net Loss Per Share

     Basic and diluted net loss per share is computed using net loss adjusted
for the accretion of the redeemable warrants and the weighted-average number of
outstanding shares of common stock.  Potentially dilutive securities, including
options, warrants, restricted common stock, and preferred stock, (amounting to
44,844,247 shares of common stock) has been excluded from the computation of
diluted net loss per share because the effect of this inclusion would be
antidilutive.  Information pertaining to potentially dilutive securities is
included in Notes 6, 7 and 8 of notes to consolidated financial statements
included in the Company's Fiscal 2000 Form 10-K.

Note 3-Revenue Recognition Policy

     The Company's contracts are generally multiple-element arrangements with a
network operator involving a combination of video-on-demand hardware products,
licenses for system software and selected content and operational services. As a
result, the Company recognizes revenue in accordance with the American Institute
of Certified Public Accountants Statement of Position 97-2 (SOP 97-2),
"Software Revenue Recognition," and Statement of Position 98-9 (SOP 98-9),
"Software Revenue Recognition, with Respect to Certain Transactions." SOP 97-2
generally requires revenue earned on software arrangements involving multiple
elements to be allocated to each element based on the relative fair values of
the elements. The fair value of an element must be based on vendor specific
objective

                                       5
<PAGE>

evidence of the relative fair values of the elements. Vendor specific objective
evidence is determined by the price charged when the element is sold separately.
SOP 98-9 requires recognition of revenue using the residual method in a multiple
element arrangement when fair value does not exist for one or more of the
delivered elements in the arrangement. Under the residual method, revenue for
the undelivered elements is deferred and subsequently recognized in accordance
with Statement of Position 97-2. Evidence of the fair value of the individual
elements in our current agreements does not exist.

     As a result, upon the delivery of the Company's video-on-demand hardware
products, revenue is recognized to the extent of the cost of these hardware
products. Any remaining product revenue is amortized on a straight-line basis
over the remaining term of the agreement. The Company recognizes license
revenues ratably over the term of the agreement. If the Company's services are
provided on a fee-for-service basis, service revenues are recognized as the
services are performed. If the services are provided on a revenue sharing basis,
service revenues are recognized based on program purchases by subscribers.

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

Item 2.  Management's Discussion and Analysis of Financial Condition and Results
of Operations


     The following discussion of our financial condition and results of
operations should be read in conjunction with the unaudited consolidated interim
financial statements for the three months and the six months ended December 31,
2000 and 1999 included elsewhere in this Form 10-Q. This discussion contains
forward-looking statements that involve risks and uncertainties. Our actual
results may differ materially from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed below. The forward-looking statements contained
herein are made as of the date hereof, and we assume no obligation to update
such forward-looking statements or to update the reasons why actual results may
differ materially from those anticipated in such forward-looking statements.
Forward-looking statements are statements identified with an asterisk (*). All
forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by the cautionary statements set forth
below and in "Factors Affecting Operating Results."

Overview

     We are a leading provider of digital video-on-demand television products
and services. We have commercially deployed our video-on-demand service with
several cable operators in North America. We have also recently introduced an
interactive program guide as a stand-alone product. Both our video-on-demand
service and interactive program guide operate on industry-standard digital set-
top boxes and operating systems and provide flexible and cost-effective
interactive television solutions for cable and other broadband operators, which
we refer to as network operators. Since our inception, we have devoted
substantially all of our resources to developing our video-on-demand and
interactive program guide products and services, establishing industry
relationships, carrying out initial marketing activities, negotiating deployment
agreements and establishing the operations necessary to support the commercial
deployment of our video-on-demand products and services.

                                       6
<PAGE>

     Prior to June 1999, we offered our video-on-demand service only as a
complete system solution for network operators. Under this approach, we own,
install and fund all hardware and software components of our system. We manage
and deliver the complete video-on-demand service offering to cable subscribers.
We generate revenues from deployment agreements with network operators based on
a share of the revenues generated by the network operators from video-on-demand
revenues and other monthly subscriber fees.

     Beginning in June 1999, we shifted our sales and marketing strategy to
emphasize selling our video-on-demand hardware products, licensing our system
software, and providing a suite of content acquisition and operational support
services on an a la carte basis to network operators. Under this approach, the
network operator purchases the video-on-demand system hardware and takes the
capital and operating expense risk associated with such ownership. The network
operator licenses our system software and can then select the other video-on-
demand support services it wants to utilize. The network operator can select
either the entire package of content and operational support services and pay us
a portion of the revenues they receive from video-on-demand services, or select
some or all of these services on a fee-for-service basis. We expect that the
substantial majority of our future revenues will be derived from this new
strategy.*

     Through December 31, 2000, we have generated minimal revenues and have
incurred significant losses and substantial negative cash flow, primarily due to
engineering and development expenditures and other costs required to develop our
video-on-demand products and services. Since our inception through December 31,
2000, we have an accumulated deficit of $388.2 million and have not achieved
profitability on a quarterly or annual basis. We expect to continue to incur
substantial net losses and negative cash flow for at least the next few years.*
Our historical revenues and expenditures are not necessarily indicative of, and
should not be relied upon as an indicator of, revenues that may be attained or
expenditures that may be incurred by us in future periods.*

Revenues

     Revenue is comprised of three components: product revenue resulting from
the sale of our video-on-demand hardware products; licensing revenue resulting
from the licensing of our systems software and on-screen video-on-demand
navigator applications; and service revenue resulting from programming services
and operations support services. Since our inception through December 31, 2000,
we have not recognized any revenue from our interactive program guide.

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

                                       7
<PAGE>

subsequently recognized in accordance with Statement of Position 97-2. Evidence
of the fair value of the individual elements in our current agreements does not
exist.

     As a result, upon the delivery of our video-on-demand hardware products,
revenue is recognized to the extent of the cost of these hardware products. Any
remaining product revenue is amortized on a straight-line basis over the
remaining term of the agreement. We recognize license revenues ratably over the
term of the agreement. If our services are provided on a fee-for-service basis,
service revenues are recognized as the services are performed. If the services
are provided on a revenue sharing basis, service revenues are recognized based
on program purchases by subscribers.

 Operating Expenses

     Cost of Product Revenue. Cost of product revenue consists of contract
manufacturing costs, component and material costs, and other direct product
expenditures associated specifically with our video-on-demand hardware products.

     Programming. Programming expense includes license fees payable to content
providers, costs related to the acquisition and production of digitally encoded
programming content (including movies, videos, previews and promotions) and
content duplication and distribution expenses.

     Operations. Operations expense includes the cost of field operations, both
for initial launches and for ongoing support of our installed video-on-demand
base. These costs include personnel and other costs for technical support,
customer service training, installation, launch support, and maintenance costs
for our video-on-demand system. In addition, operations expense includes
personnel and other costs which support our ongoing manufacturing relationships
for our video-on-demand hardware products with third-party manufacturers. We
expect operations expense to increase in the future due to an increase in the
manufacture and sale of our video-on-demand hardware.* To the extent network
operators elect to contract with us for operations support, operations expense
would increase in the area of field support and maintenance.

     Engineering and Development. Engineering and development expense consists
of salaries, consulting fees, prototype hardware and other costs to support
product development. Our engineering and development efforts involve ongoing
system software development, system integration and new technology. To date, the
most substantial portion of our operating expenses have been engineering and
development expense. We expect to continue to incur significant engineering and
development expenditures for continued development and enhancements to our
video-on-demand products and services.* We believe these expenditures are
necessary to remain competitive, to assure our products and services are
integrated with industry standards and to offer new services, such as our
recently introduced interactive program guide, and enhancements to our
customers.

     Sales and Marketing. To date, our sales and marketing expense has consisted
of the costs of marketing our video-on-demand products and services to network
operators and their customers and has included business development and
marketing personnel, travel expenses, trade shows, consulting fees and
promotional costs. Historically, our sales and marketing expense has also
included telemarketing, direct mailings, targeted advertising and promotional
campaigns, and other direct marketing costs related to acquiring subscribers
under our end-to-end video-on-demand service. In the future, we expect that
direct marketing costs will not represent a significant component of total sales
and marketing expense, as

                                       8
<PAGE>

most network operators will take responsibility for marketing video-on-demand
services to their subscribers.* To the extent we provide these services, they
will likely be performed under individual service agreements with the network
operators and, accordingly, will fluctuate with revenues. Our future sales and
marketing costs will consist primarily of market development and product
management expenses.*

     General and Administrative. General and administrative expense consists
primarily of salaries and related expenses of management and administrative
personnel, professional fees and general corporate and administrative expenses.
In addition, general and administrative expense includes costs associated with
the development, support and growth of our management information system
infrastructure. We expect general and administrative expense to increase over
time to support the expansion of our business activities.*

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

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

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

Other Income and Expense

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

Results of Operations

Revenue

     Total revenue for the three months ended December 31, 2000 was $1.1 million
compared to $1.0 million for the three months ended December 31, 1999. Total
revenue for the six months ended December 31, 2000 was $1.5 million, compared to
$1.1 million for the six months ended December 31, 1999.

                                       9
<PAGE>

     Product revenue. Product revenue for the three months ended December 31,
2000 and December 31, 1999 was $18,000 and $944,000, respectively. Product
revenue for the six months ended December 31, 2000 and December 31, 1999 was
$53,000 and $944,000, respectively. Our new generation video-on-demand hardware
products were in the beta test stage through December 31, 2000. As a result
minimal product revenues were recognized. Revenue recognized for the six months
ended December 31, 1999 is related to our older generation hardware, which has
been since discontinued.

     License revenue. License revenue was $45,000 for the three months ended
December 31, 2000.  We did not record any license revenue for the three months
ended December 31, 1999. License revenue was $81,000 for the six months ended
December 31, 2000.  We did not record any license revenue for the six months
ended December 31, 1999. License revenue is the fee for our system manager and
increases are based upon digital subscribers served.

     Service revenue. Service revenue was $1.0 million and $103,000 for the
three months ended December 31, 2000 and 1999, respectively. Service revenue was
$1.3 million and $171,000 for the six months ended December 31, 2000 and 1999,
respectively. This increase in service revenue was due to the recognition of
$589,000 of revenue in the current period resulting from an adaptive
engineering agreement with a network operator and an increase in subscribers
under revenue sharing arrangements.

Operating Expenses

     Cost of Product Revenue. Cost of product revenue was $553,000 and $1.1
million for the three months ended December 31, 2000 and December 31, 1999,
respectively. Cost of product revenue was $738,000 and $1.1 million for the six
months ended December 31, 2000 and December 31, 1999, respectively. Cost for the
three and six months ended December 31, 1999 consisted of production-related
non-recurring engineering and adjustments to product standard costs as purchased
volumes increased and commercial production of our new generation video-on-
demand hardware commenced.

     Programming. Programming expense was $878,000 and $1.0 million for the
three months ended December 31, 2000 and 1999, respectively. Programming expense
was $1.9 million and $2.3 million for the six months ended December 31, 2000 and
1999, respectively. The decrease in programming expense was primarily
attributable to reduced labor and other related program production service
costs. The six months ended December 31, 2000 reflect this reduced level of
expenditures when compared to the six months ended December 31, 1999.

     Operations. Operations expense was $1.8 million and $1.5 million for the
three months ended December 31, 2000 and 1999, respectively. Operations expense
was $3.6 million and $3.0 million for the six months ended December 31, 2000 and
1999, respectively. The increase in operations expense was primarily
attributable to increased personnel costs in the manufacturing area as we
commercially introduced our video-on-demand products and services in multiple
network operators' plants and increased expenses related to operations activity
in our United Kingdom office.

     Engineering and Development.  Engineering and development expense was $7.7
million and $6.9 million for the three months ended December 31, 2000 and 1999,
respectively. Engineering and

                                       10
<PAGE>

development expense was $15.7 million and $12.2 million for the six months ended
December 31, 2000 and 1999, respectively. The increase in engineering and
development expense was attributable to an increase in expenditures for the
development of new products and services such as our interactive program guide
and integration activities related to digital broadcast platforms and middleware
applications required for deployment by network operators. Included in
engineering and development expenses for the six months ended December 31, 2000
was $2.2 million in development related expenses pursuant to a development
contract with a third party. There was no similar expense for the six months
ended December 31, 1999.

     Sales and Marketing. Sales and marketing expense was $1.8 million and $1.7
million for the three months ended December 31, 2000 and 1999, respectively.
Sales and marketing expense was $3.3 million and $3.3 million for the six months
ended December 31, 2000 and 1999, respectively. There was no variance in sales
and marketing expense between the six months ended December 31, 2000 and 1999.

     General and Administrative. General and administrative expense was $6.1
million and $4.1 million for the three months ended December 31, 2000 and 1999,
respectively. General and administrative expense was $11.6 million and $8.8
million for the six months ended December 31, 2000 and 1999, respectively.
Overall, these expenses have increased as a direct result of the growth of our
operations, which has resulted in an increase in personnel related expenses. In
addition to the increase in personnel costs, the increase in general and
administrative expense can be attributed to an increase in facilities related
expenses due to the relocation of our corporate headquarters to a new facility,
increased patent and legal expenses and professional services expenses related
to the filing of a registration statement on Form S-1.

     Depreciation and Amortization.  Depreciation and amortization expense was
$1.5 million and $1.8 million for the three months ended December 31, 2000 and
1999. Depreciation and amortization expense was $3.0 million and $3.3 million
for the six months ended December 31, 2000 and 1999.

     Amortization of Deferred Stock Compensation.  Amortization of deferred
stock compensation expense was $1.1 million and $180,000 for the three months
ended December 31, 2000 and 1999, respectively. Amortization of deferred stock
compensation expense was $2.2 million and $385,000 for the six months ended
December 31, 2000 and 1999. The increase in deferred stock compensation expense
was related to an increase in stock options granted to employees and
consultants. We expect to continue to grant options to employees, which may
result in an increase in deferred stock-based compensation, which will be
amortized over the applicable vesting periods of the options.

Other Income and Expenses

     Interest income was $1.4 and $1.5 million for the three months ended
December 31, 2000 and 1999, respectively. Interest income was $2.1 and $3.1
million for the six months ended December 31, 2000 and 1999, respectively. The
decrease in interest income is the result of a decrease in cash and cash
equivalent balances, which are invested in short-term, interest bearing accounts
and a decrease in short-term investments. Gain on sale of investments was $11.5
million and $24.4 million for the three months and six months ended December 31,
2000, respectively. Gain on sale of investment is due to the sale of shares of
PMC-Sierra, Inc. common stock previously acquired by us in connection with the
acquisition by PMC-Sierra, Inc., of a company in which we held a small minority
interest. Interest expense was $11.0 million and $9.6 million for the three
months ended December 31, 2000 and 1999, respectively.

                                       11
<PAGE>

Interest expense was $16.3 million and $18.8 million for the six months ended
December 31, 2000 and 1999, respectively. Included in interest expense for the
six months ended December 31, 2000 is a gain on the revaluation of redeemable
put warrants of $4.7 million.

Provision for Income Taxes

     We have not provided for or paid federal income taxes due to our net
losses. As of June 30, 2000, we had net operating loss carryforwards of
approximately $215.7 million to offset future income subject to federal income
taxes and $112.9 million available to offset future California taxable income.
As of June 30, 2000, we had $21.8 million in net operating losses to offset
future New Jersey taxable income and we had $11.0 million in net operating
losses to offset future Pennsylvania taxable income. The extent to which such
loss carryforwards can be used to offset future taxable income may be limited
because of ownership changes pursuant to Section 382 of the Internal Revenue
Code of 1986, as amended.


Liquidity and Capital Resources

     From inception through December 31, 2000, we have financed our operations
primarily through the gross proceeds of private placements totaling
approximately $108.3 million of equity and $250.0 million of high yield debt
securities, net of repayments. During the six months ended December 31, 2000, we
raised $5.0 million by issuing preferred stock to Charter Communications. At
December 31, 2000, we had cash and cash equivalents and short-term investments
totaling $76.8 million.

     On February 19, 1998, we received $250.0 million in gross proceeds from an
offering of 463,000 units consisting of senior discount notes with an aggregate
principal amount at maturity of $463.0 million and warrants to purchase an
aggregate of 2,778,000 shares of common stock. The notes are senior unsecured
indebtedness, and rank pari passu with any future unsubordinated unsecured
indebtedness. The notes will be senior to any future subordinated indebtedness,
but effectively will be subordinated to any future secured indebtedness.

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

     The senior discount notes were sold at a significant discount, and must be
repaid at maturity on March 1, 2008. Commencing September 1, 2003, we are
required to make semi-annual interest payments of $29.2 million, based on the
aggregate par value of $463.0 million. There are no principal payments due on
the senior discount notes prior to maturity on March 1, 2008.

     The net proceeds from the offering of the notes were approximately $199.9
million, after deducting placement fees and other offering costs, the
extinguishment of all the subordinated discount notes issued in a previous
offering and a premium paid in connection with the early extinguishment of these
notes. In connection with the offering, we allocated approximately $18.1 million
of the proceeds to the warrants.

                                       12
<PAGE>

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

     We believe our cash, cash equivalents and short-term investments will be
sufficient to satisfy our cash requirements at minimum through the current
fiscal year.* Thereafter, our projections indicate that we will need to raise
significant additional funds to support our operations.* However, we may need to
raise additional funds earlier if our estimates of working capital and operating
expenditure requirements change or prove to be inaccurate. We may also need to
raise significant additional funds in order to respond to unforeseen
technological or marketing hurdles or to take advantage of unanticipated
opportunities. We have no present commitments or arrangements assuring us of any
future equity or debt financing, and there can be no assurance that we will be
able to obtain any such equity or debt financing on favorable terms or at all.
In the event that we are unable to obtain such additional capital, we will be
required to delay the expansion of our business or take other actions that would
harm our business and our ability to achieve sufficient cash flow to service our
indebtedness. To the extent we raise additional cash by issuing equity
securities, our existing stockholders will be diluted.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Market Risk Disclosures

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

Interest Rate Sensitivity

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

                                       13
<PAGE>

     Our short-term investments have generally been available-for-sale. Gross
unrealized gains and losses were not significant as of December 31, 2000.

     The following table presents the principal amounts and related weighted-
average yields for our fixed rate investment portfolio (in thousands, except
average yields) at December 31, 2000.


                                             Carrying  Average
                                              Amount    Yield
                                             --------  --------
U.S. government obligations                   $24,040     6.14%
Commercial paper                               43,604     6.59%
Certificates of deposits                        2,128     3.81%
Money market instruments                        2,287     6.27%
Auction rate preferred stock certificates       4,700     6.72%
                                              -------
                 Total                        $76,759

Included in cash and cash equivalents          38,783
Included in short-term investments             37,976
                                              -------
                 Total                        $76,759
                                              =======


Foreign Currency Risks

     We believe that our exposure to currency exchange fluctuation risk is
insignificant because our transactions with international vendors are generally
denominated in U.S. dollars, which is considered to be the functional currency
for our company and subsidiaries. The currency exchange impact on intercompany
transactions was $39,000.


Factors Affecting Operating Results

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

     We expect to continue to generate substantial net losses and negative cash
flow for the next few years. We may be unable to achieve a level of cash flow
from operations sufficient to permit us to pay the principal and interest on our
current indebtedness and any additional indebtedness we may incur. The senior
discount notes were sold at a significant discount and must be repaid at
maturity on March 1, 2008. Commencing September 1, 2003, we are required to make
semi-annual interest payments of $29.2 million, based on the aggregate par value
of $463.0 million. Our ability to make scheduled debt service payments will
depend upon our ability to achieve significant and sustained growth in our cash
from operations and to complete necessary additional financings.

                                       14
<PAGE>

     If we are unable to generate sufficient cash from operations to service our
indebtedness, we may have to forego or delay development and enhancement of
interactive products and services, restructure or refinance our indebtedness or
seek additional equity capital or debt financing. We may not be able to effect
any refinancing or new financing strategy on satisfactory terms, if at all. If
we fail to satisfy our obligations with respect to our indebtedness, this could
result in a default under the indenture governing our senior discount notes and
could cause a default under agreements governing our other indebtedness. In the
event of a default, the holders of indebtedness would have enforcement rights,
including the right to accelerate the debt and the right to commence an
involuntary bankruptcy proceeding against us. Absent successful commercial
deployments of our interactive products and services, ongoing technical
development and enhancement of our solution and significant growth of our cash
flow, we will not be able to service our indebtedness.

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

     We are highly leveraged. As of December 31, 2000, we had senior discount
notes payable of approximately $333.4 million. The senior discount notes were
sold at a significant discount and must be repaid at maturity on March 1, 2008
at the aggregate par value of $463.0 million. The degree to which we are
leveraged could have important consequences to us and our investors, including,
but not limited to, the following:

 . our ability to obtain additional financing in the future for working capital,
  operating expenses in connection with system deployments, development and
  enhancement of our interactive products and services, capital expenditures,
  acquisitions and other general corporate purposes may be materially limited or
  impaired;
 . our cash flow, if any, will not be available for our business because a
  substantial portion of our cash flow must be dedicated to the payment of
  principal and interest on our indebtedness;
 . the terms of future permitted indebtedness may limit our ability to redeem our
  outstanding senior discount notes in the event of a change of control; and
 . our high degree of leverage may make us more vulnerable to economic downturns,
  may limit our ability to withstand competitive pressures and may reduce our
  flexibility in responding to changing business and economic conditions.

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

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

 . incur additional indebtedness;
 . create liens upon assets;
 . apply the proceeds from the disposal of assets;
 . make investments;
 . make dividend payments and other distributions on capital stock; and
 . redeem capital stock.

                                       15
<PAGE>

     These covenants may limit our ability to finance our future operations or
to engage in other business activities that may be in our best interest.

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

     We are an early stage company with limited commercial operating history. We
have generated revenues of $3.8 million and have incurred net losses of
approximately $388.2 million since our inception through December 31, 2000. We
expect to continue to incur substantial losses and experience substantial
negative cash flow for at least the next few years as we continue to develop our
operations capability and sell and license our interactive products and
services. We do not expect to generate substantial revenues unless and until our
interactive products and services are deployed at a significant number of
additional cable systems and a significant number of viewers access our video-
on-demand, interactive program guide and other interactive services enabled by
our technology. If we do not achieve and sustain profitability in the future, we
may be unable to continue our operations.

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

 . the extent to which cable operators upgrade their cable plant to enable two-
  way operation and deploy digital set-top boxes;
 . our ability to enter into agreements for broad distribution of our interactive
  products and services to cable operators;
 . the extent to which consumers accept and use interactive, on-demand television
  enabled by our video-on-demand products and services;
 . our ability to continue integrating our software and hardware with other
  digital applications and services selected by network operators in the United
  States and internationally, including set-top boxes, application managers and
  set-top box operating systems, cable system components and electronic program
  guides;
 . the extent to which third-party cable equipment suppliers integrate their
  headend products with our equipment and reduce the cost and physical space
  requirements for their equipment;
 . our ability to further reduce the physical space requirements for our video
  server and other headend equipment;
 . our ability to continue technical development of our video server, our access
  equipment, our service software and our other video-on-demand system
  components in order to reduce their manufacturing cost and enhance their
  functionality; and
 . our ability to operate existing contracted video-on-demand deployments with
  acceptable system performance and viewer acceptance.

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

     Our limited operating history makes it very difficult to evaluate our
business and future prospects. As a result of our limited operating history, it
is difficult for us to accurately forecast our

                                       16
<PAGE>

revenues, and we have limited meaningful historical financial data on which to
base planned operating expenses. We are unable to accurately forecast our
revenues because:

 . we participate in an emerging market;
 . our current video-on-demand deployment agreements with network operators are
  for selected systems, and we are unable to predict whether they will be
  expanded to cover additional systems;
 . changes in cable operators' financial condition or priorities may result in
  delayed or slowed deployments under existing or future agreements;
 . we cannot predict the rate at which cable subscribers will accept and utilize
  video-on-demand;
 . we cannot predict whether, or the rate at which, network operators will deploy
  the interactive guide and other interactive services, or the rate at which,
  such interactive services will be accepted and utilized by consumers;
 . we expect to sign new sales, service and licensing agreements on an irregular
  basis, if at all, and there may be long periods of time during which we do not
  enter into new agreements or expanded arrangements; and
 . we have a lengthy sales cycle, which makes it difficult to forecast the
  quarter during which a sale will occur.

     We have recently expanded our sales and marketing strategy, from one under
which we owned all hardware and software components of our video-on-demand
system and delivered the video-on-demand service offering to cable subscribers,
to include the option under which the network operator purchases, owns and
maintains all or part of the video-on-demand system hardware and takes the
capital and operating expense risk associated with such ownership. It is
difficult to predict the timing and amount of revenue that will be generated
following this change in strategy.

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

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

 . the timing of deployments by network operators of our interactive products and
  services;
 . the terms of our contractual arrangements with network operators, who may
  either contract to have us manage and operate an end-to-end solution or
  purchase software and hardware components separately to create their own
  video-on-demand systems;
 . the mix of services revenues, which depends on the extent to which network
  operators purchase services from us on a fee-for-service basis or a revenue
  sharing basis;
 . competitive pressure, which may cause us to change our pricing structures; and
 . demand for and viewer acceptance of video-on-demand and other interactive
  services.

     A significant portion of our operating expenses are relatively fixed and
necessary to develop our business. These expenses are largely independent of the
revenue generated in any given quarter from sales of products and services to
network operators. To the extent that increased expenses are not

                                       17
<PAGE>

subsequently followed by increased revenues, our operating results will suffer.
If revenue falls below expectations in any quarter, the adverse impact of the
revenue shortfall on operating results in that quarter may be increased by our
inability to adjust fixed spending to compensate for the shortfall.

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

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

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

 . our interactive products and services are reliable and scalable and integrate
  with products and services provided by other industry suppliers chosen by the
  network operator;
 . video-on-demand is a compelling consumer product and viewers will purchase
  video-on-demand content at prices and in quantities that will justify the
  network operator's investment in our video-on-demand products and services
  rather than alternative entertainment services such as pay-per-view and near-
  video-on-demand;
 . our video-on-demand and interactive program guide products are compatible with
  industry standards as they evolve; and
 . our technology enables the network operator to add new revenue generating
  services.

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

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

     Our existing deployments with Charter, Insight and AT&T currently serve a
small percentage of each company's customer base. These network operators may
not continue these deployments beyond the terms of our existing agreements, and
they may choose not to broadly deploy our video-on-demand solution in existing
or additional cable systems. In the past, we had limited scope video-on-demand
trials with other network operators that did not result in broad deployments. If
we are unable to add a substantial number of cable systems to the existing
contracts with the network operators currently deploying our products and
services, and if video-on-demand is not broadly deployed in each cable

                                       18
<PAGE>

system under contract, our results of operations will suffer. In addition, our
reputation and our ability to enter into agreements with other network operators
could be impaired.

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

     Our video-on-demand service and interactive program guide require
deployment on cable systems upgraded to hybrid fiber-coaxial architecture with
the return path from the customer to the headend activated to enable two-way
operation. According to the Cablevision Blue Book, approximately 45% of the
total U.S. homes passed by cable had been upgraded to hybrid fiber-coaxial
architecture with return path capability at the end of 1998, but only a limited
portion of the upgraded plant is currently activated for two-way transmission.
The failure of network operators to complete planned upgrades in a timely and
satisfactory manner, and the lack of suitable cable plant, would harm our
business.

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

 . the rate at which network operators upgrade their cable infrastructures and
  deploy digital set-top boxes;
 . the ability of network operators to provide timely and effective marketing
  campaigns coordinated with the launch of video-on-demand;
 . the ability of network operators to maintain their cable infrastructure and
  headends in accordance with system specifications provided by us;
 . the success of network operators in marketing video-on-demand service;
 . the prices that network operators set for video-on-demand movies and other
  content and for installation or activation of video-on-demand service;
 . the speed at which network operators can complete the installations required
  to initiate service for new subscribers;
 . the quality of customer and technical support provided by us and network
  operators; and
 . the availability and quality of content delivered to subscribers through
  video-on-demand service.

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

     We expect rapid technological developments to occur in the market for
interactive home video entertainment products and services. As a result, we have
modified and expect to continue to modify our engineering and development plans.
These modifications have resulted in delays and increased costs. Furthermore, we
expect that we will be required to continue to enhance our current interactive
products and services and develop and introduce increased functionality and
performance to keep pace with technological developments and consumer
preferences. In addition, we may not be successful in developing and marketing
product and service enhancements or new services that respond to technological
and market changes, and we may experience difficulties that could delay or
prevent the successful development, introduction and marketing of such new
product and service enhancements. Our failure to successfully develop these
products could harm our business. We have encountered delays in

                                       19
<PAGE>

product development, service integration and field tests, and other difficulties
affecting both software and hardware components of our system and our ability to
operate successfully over hybrid fiber-coaxial plant. In addition, many of our
competitors have substantially greater resources than us to devote to further
technological and new product development. Technological and market changes or
other significant developments by our competitors may render our video-on-demand
and interactive program guide products and services obsolete.

Our interactive program guide is a new product that has not been accepted by
network operators and competes with well-established products from competitors
having significantly greater resources

     Our interactive program guide is a new product in a well-established
market. The market for on-screen electronic program guides has one major
participant, Gemstar-TV Guide. Our existing program guide is already broadly
deployed by network operators. Our guide competes for access to this established
subscriber base as these network operators upgrade their systems. Our
interactive guide also competes with interactive guides being introduced by
Gemstar-TV Guide and with an interactive program guide currently being deployed
by Interactive Channel. We expect that our interactive program guide will not be
broadly deployed until its features are fully developed and field tested. In
addition, network operators' acceptance of our interactive program guide will
depend on the appeal of our business model for the guide, which is unproven. As
a result, network operators may not accept our interactive program guide and may
choose to use guides from more well-established competitors, particularly
Gemstar-TV Guide.  Gemstar-TV Guide has significantly greater resources than we
do, and also has an exclusive long-term agreement with the largest U.S. cable
operator, AT&T. Consequently, we may not be able to compete effectively or at
all in the electronic program guide market.

If we do not obtain substantial additional funds in the future, we may be unable
to continue to grow our business or repay our indebtedness

     We will require substantial additional funds in order to continue the
development, sale, license and provision of our video-on-demand and interactive
program guide products and services and, commencing on September 1, 2003, to
make cash interest payments on our indebtedness. We have made and expect to
continue to make significant investments in working capital in order to fund
development activities, commercially deploy our video-on-demand service, sell
our products and services and fund operations. We expect to continue to incur
significant operating losses and expect that our operating cash flow will be
increasingly negative over at least the next few years. We believe our existing
cash, cash equivalents and short-term investments will be sufficient to meet our
cash requirements through the end of the current fiscal year.* Thereafter, we
will need to raise significant additional funds to support our operations.
However, we may need to raise additional funds earlier if our estimates of
working capital or capital expenditure requirements change or prove to be
inaccurate. We may also need to raise significant additional funds in order to
respond to unforeseen technological, marketing or competitive hurdles or to take
advantage of unanticipated opportunities.

     We have no present commitments or arrangements assuring us of any future
equity or debt financing, and we may not be able to obtain any equity or debt
financing on favorable terms or at all. In the event that we are unable to
obtain additional capital, we will need to delay the expansion of our business
or take other actions that could harm our business and may need to cease
operations. We may also not be able to pay interest and principal on our
indebtedness when due.

                                       20
<PAGE>

Our lengthy sales cycle may cause fluctuations in our operating results

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

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

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

 . server manufacturers, such as Concurrent, nCUBE and SeaChange;
 . software providers, such as Prasara and Scientific-Atlanta; and
 . system integrators, such as Time Warner and Scientific-Atlanta.

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

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

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

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<PAGE>

 . companies that deliver in-home video entertainment over networks, such as
  regular telephone lines, digital subscriber lines, or DSL, satellite or the
  Internet, and some providers of video streaming technology; and
 . companies that enable the viewer to store and access content on an "on-demand"
  basis, including providers of personal video recorders, such as TiVo and
  Replay, and companies that rent and sell videotapes.

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

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

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

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

     Our future success depends, in part, on our ability to protect our
intellectual property and maintain the proprietary nature of our technology
through a combination of patents, licenses and other intellectual property
arrangements. We have been awarded patents and have filed applications and
intend to file additional applications for patents covering various aspects of
our video-on-demand and interactive program guide products and services. Any
patents issued may be challenged, invalidated or circumvented, and the rights
granted under any patents may not provide proprietary protection to us. We may
not be successful in maintaining these proprietary rights, and our competitors
may independently develop or patent technologies that are substantially
equivalent or superior to our technologies. To the extent we integrate our
products with those of third parties, including competitors, we may be required
to disclose or license intellectual property to those companies, and these
companies could appropriate our technology or otherwise improperly exploit the
information gained through this integration. If we believe third parties are
infringing our intellectual property, we may be forced to expend significant
resources enforcing our rights or suffer competitive injury.

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<PAGE>

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

     From time to time, we have received notices from third parties claiming
infringement of intellectual property rights. Although we do not believe that we
infringe any third party's intellectual property rights, we could encounter
similar claims or litigation in the future. Gemstar-TV Guide, a primary provider
of electronic program guides, has actively assembled and continues to acquire a
portfolio of intellectual property in the field, and has aggressively sought
recourse against any parties that it believes infringes its intellectual
property. Although we believe that our interactive program guide does not
infringe any published patents of Gemstar-TV Guide and have not been served
notice of any potential infringement, this provider may make such a claim in the
future, which could result in legal action. Because patent applications in the
United States are not publicly disclosed until the patent has been issued,
applications may have been filed that, if issued as patents, would relate to our
products. In addition, we have not completed a comprehensive patent search
relating to the technology used in our video-on-demand and interactive program
guide products and services.

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

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

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

     Various subassemblies and components used in our video server and access
equipment are procured from single sources and others are procured only from a
limited number of sources. Consequently, we may be adversely affected by
worldwide shortages of components, significant price increases, reduced control
over delivery schedules, and manufacturing capability, quality and cost.
Although we believe alternative suppliers of products, services, subassemblies
and components are available, the lack of alternative sources could harm our
ability to deploy our video-on-demand and interactive program guide systems.
Manufacturing lead times can be as long as nine months for some

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<PAGE>

critical components. Therefore, we may require significant working capital to
pay for such components well in advance of both hardware orders and revenues.
Moreover, a prolonged inability to obtain components could harm our business and
could result in damage to network operator relationships.

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

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

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

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

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

We intend to expand our international offering and operations, and these efforts
may not be successful in generating revenues sufficient to offset the associated
expense

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

 . unexpected changes in regulatory requirements and tariffs that may be imposed
  on our services ;
 . difficulties and costs of staffing and managing international operations;
 . differing technology standards and difficulties in obtaining export and import
  licenses;
 . longer payment cycles, difficulties in collecting accounts receivable and
  longer collection periods;
 . political and economic instability;
 . fluctuations in currency exchange rates;
 . imposition of currency exchange controls;
 . potentially adverse tax consequences; and
 . reduced protection for intellectual property rights in some countries.

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

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

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

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

Insiders have significant influence over our efforts

     Our major stockholders and directors, together with entities affiliated
with them, own approximately 62.4% of our outstanding Common Stock (assuming
conversion of all outstanding Preferred Stock into Common Stock) at December 31,
2000. Accordingly, these stockholders have significant influence over our
affairs. This concentration of ownership could have the effect of delaying or
preventing a change in control of the Company.

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PART II  OTHER INFORMATION

     Item 1, Item 3, Item 4 and Item 5 are not applicable with respect to the
current reporting period.

     Item 2.  Changes in Securities and Use of Proceeds

     During the three months ended December 31, 2000, we issued and sold an
aggregate of 187,434 shares of Common Stock to our employees and consultants for
an aggregate purchase price of $280,931 pursuant to exercises of options under
its 1995 and 1998 Stock Plans. These issuances were deemed exempt from
registration under the Securities Act of 1933, as amended, in reliance upon Rule
701 promulgated thereunder.

     During the three months ended December 31, 2000, we issued (i) 1000 shares
of Common Stock for an aggregate purchase price of $2,000 pursuant to the
exercise of warrants, and (ii) 67,992 shares of Preferred B Stock for an
aggregate purchase price of $58,133 pursuant to the exercise of warrants. These
issuances were deemed exempt from registration under the Securities Act of 1933,
as amended, in reliance upon Section 4(2) and Regulation D promulgated
thereunder.

     Item 6.  Exhibits and Reports on Form 8-K:

              a.  Exhibits.

                  None.

              b.  Reports on Form 8-K.

                  No reports on Form 8-K were filed with the Securities and
                  Exchange Commission during the quarter ended December 31,
                  2000.

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                                   SIGNATURES

     Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.

                                  DIVA SYSTEMS CORPORATION



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


Dated: February 12, 2001

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