<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 March 31, 2001.

                                       or

     [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934 for the transition period from ____________ to
         ____________.


                         Commission File No. 333-64483


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


                    Delaware                                  94-3226532
            (State or other jurisdiction of                 (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.  [_] Yes  [X] No


     The number of shares of Registrant's classes of Common Stock at April 30,
2001 was:

            Title of each class
            -------------------
        Common Stock, $.001 par value                 18,201,659
        Class C Common Stock, $.001 par value            857,370
<PAGE>

                            DIVA SYSTEMS CORPORATION

                         Quarterly Report on Form 10-Q

                               Table of Contents

                          Quarter Ended March 31, 2001



                         PART I - FINANCIAL INFORMATION

Item 1.    Consolidated Financial Statements (Unaudited)
              Condensed Consolidated Balance Sheet at March 31, 2001 and
              June 30, 2000                                                    1
              Condensed Consolidated Statement of Operations for the three
              months and nine months ended March 31, 2001 and 2000             2
              Condensed Consolidated Statement of Cash Flows for the nine
              months ended March 31, 2001 and 2000                             3
              Notes to Condensed Consolidated Financial Statements             4
Item 2.    Management's Discussion and Analysis of Financial Condition and
           Results of Operations                                               5
Item 3.    Quantitative and Qualitative disclosures about Market Risk         13



                          PART II - OTHER INFORMATION

Item 2.    Changes in Securities and Use of Proceeds                          26
Item 6.    Exhibits and Reports on Form 8-K                                   26
Signatures                                                                    27
<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>
                                                                                        March 31,                  June 30,
                                                                                          2001                       2000
                                                                                    ----------------           ----------------
<S>                                                                               <C>                         <C>
                       Assets
Current assets:
   Cash and cash equivalents                                                        $     46,315               $     66,253
   Short-term investments                                                                 11,123                     26,429
   Accounts receivable                                                                     6,149                        264
   Inventory                                                                              17,284                      3,143
   Prepaid expenses and other current assets                                                 759                      3,520
                                                                                    ----------------           ----------------
          Total current assets                                                            81,630                     99,609

Property and equipment, net                                                               12,087                     12,648
Debt issuance costs, net                                                                   5,140                      6,500
Deposits and other assets                                                                    591                        596
Intangible assets, net                                                                        --                        134
                                                                                    ----------------           ----------------
          Total assets                                                              $     99,448               $    119,487
                                                                                    ================           ================

   Liabilities, Redeemable Warrants and Stockholders' Deficit

Current liabilities:
   Accounts payable                                                                 $     10,570               $      5,121
   Other current liabilities                                                               1,973                      4,441
   Deferred revenue                                                                        4,377                      1,015
   Current portion of capital lease obligation                                               722                        676
                                                                                    ----------------           ----------------
          Total current liabilities                                                       17,642                     11,253

Notes payable                                                                            344,229                    312,815
Redeemable put warrants                                                                    7,326                     11,989
Long - term portion of lease payable                                                         482                      1,029
Deferred rent                                                                                868                        780
                                                                                    ----------------           ----------------
          Total liabilities                                                              370,547                    337,866
                                                                                    ----------------           ----------------
Redeemable warrants
                                                                                           5,110                      7,007
Commitments and contingencies                                                       ----------------           ----------------

Stockholders' deficit:
   Preferred stock, $0.001 par value; 80,000,000 shares authorized;
      25,120,502 and 24,495,463 shares issued and outstanding
      as of March 31, 2001, and June 30, 2000, respectively.
   Common stock, $0.001 par value; 165,000,000 shares authorized;                             25                         24
      19,059,029 and 18,615,618 shares issued and outstanding as
      of March 31, 2001, and June 30, 2000, respectively.                                     19                         19
   Additional paid-in capital                                                            147,617                    138,211
   Deferred compensation                                                                  (4,448)                    (5,954)
   Accumulated deficit                                                                  (419,422)                  (357,686)
                                                                                    ----------------           ----------------
          Total stockholders' deficit                                                   (276,209)                  (225,386)
                                                                                    ----------------           ----------------
          Total liabilities, redeemable warrants and stockholders' deficit          $     99,448               $    119,487
                                                                                    ================           ================
See accompanying notes to interim condensed consolidated financial statements.
</TABLE>

                                       1
<PAGE>

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

<TABLE>
<CAPTION>
                                                                  Three Months Ended             Nine Months Ended
                                                                      March 31,                     March 31,
                                                                 2001           2000            2001          2000
                                                             ------------   ------------     ------------   -----------
<S>                                                         <C>             <C>            <C>              <C>
Revenues:
     Product                                                 $    4,502     $     436        $    4,555     $   1,380
     License                                                      1,869            16             1,950            16
     Service                                                        583           132             1,927           303
                                                             ------------   ------------     ------------   -----------
             Total revenues                                       6,954           584             8,432         1,699

Operating expenses:
     Cost of revenue                                              6,699         2,555             7,437         3,658
     Programming                                                  1,427           983             3,352         3,248
     Operations                                                   1,309         1,738             4,897         4,738
     Engineering and development                                  9,253         7,494            24,943        19,697
     Sales and marketing                                          1,902         1,645             5,167         4,938
     General and administrative                                   4,777         5,756            16,368        14,514
     Depreciation and amortization                                1,445         2,095             4,478         5,370
     Warrant expense                                                323             -               389             -
     Amortization of stock compensation                             801         1,255             3,021         1,640
                                                             ------------   ------------     ------------   -----------
             Total operating expenses                            27,936        23,521            70,052        57,803
                                                             ------------   ------------     ------------   -----------
             Operating loss                                      20,982        22,937            61,620        56,104
                                                             ------------   ------------     ------------   -----------
Other (income) expense:
     Interest income                                               (997)       (1,449)           (3,074)       (4,548)
     Gain on sale of investments                                      -             -           (24,421)            -
     Interest expense                                            11,286         9,903            27,611        28,720
                                                             ------------   ------------     ------------   -----------
             Total other expense, net                            10,289         8,454               116        24,172
                                                             ------------   ------------     ------------   -----------
             Net loss                                            31,271        31,391            61,736        80,276

Accretion of redeemable warrants                                    254         4,175            (1,896)        4,478
                                                             ------------   ------------     ------------   -----------
             Net loss attributable to
               common stockholders                           $   31,525     $  35,566        $   59,840     $  84,754
                                                             ============   ============     ============   ===========
Basic and diluted net loss per share:                        $     1.67     $    1.95        $     3.18     $    4.76
                                                             ============   ============     ============   ===========
Shares used in per share computation                             18,859        18,241            18,826        17,812
                                                             ============   ============     ============   ===========

See accompanying notes to interim condensed consolidated financial statements.
</TABLE>
                                       2
<PAGE>

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

<TABLE>
<CAPTION>

                                                                                              Nine Months Ended
                                                                                                  March 31,
                                                                                             2001             2000
                                                                                         ---------------- -------------

<S>                                                                                    <C>               <C>
Cash flows from operating activities:
 Net loss                                                                                $    (61,736)      $  (80,276)
 Adjustments to reconcile net loss to net
   cash used in operating activities:
     Depreciation and amortization                                                              4,478            5,370
     (Gain) loss on sale of property and equipment                                                (40)              82
     Inventory write down                                                                       3,812            2,477
     Amortization of debt issuance costs and
      accretion of discount on notes payable                                                   28,111           28,622
     Amortization of deferred stock compensation                                                3,021            1,640
     Warrant expense                                                                              389                -
     Gain on sale of investments                                                              (24,421)               -
     Changes in operating assets and liabilities:
       Accounts receivable                                                                     (5,885)          (1,053)
       Inventory                                                                              (17,953)            (498)
       Other assets                                                                             2,761            1,244
       Accounts payable                                                                         5,449              669
       Other current liabilities                                                               (2,468)           1,835
       Deferred revenue                                                                         3,362            1,013
       Deferred rent                                                                               88                -
                                                                                         ---------------    -------------
         Net cash used for operating activities                                               (61,032)         (38,875)
                                                                                         ---------------    -------------
Cash flows from investing activities:
     Purchases of property and equipment                                                       (3,864)         (4,985)
     Proceeds from sale of investments                                                         24,421               -
     Proceeds from the sale of assets                                                             125              40
     Proceeds from sale of short-term investments                                              20,230          11,768
     Purchases of short-term investments                                                       (4,924)              -
                                                                                         ---------------    -------------
         Net cash provided by investing activities                                             35,988           6,823
                                                                                         ---------------    -------------
Cash flows from financing activities:
     Issuance of preferred stock, net                                                           5,000           7,001
     Exercise of stock options                                                                    607           1,203
     Payments on capital lease                                                                   (501)           (255)
     Payments on note payable                                                                       -             (37)
                                                                                         ---------------    -------------
         Net cash provided by financing activities                                              5,106           7,912
                                                                                         ---------------    -------------
Net decrease in cash and cash equivalents                                                     (19,938)        (24,140)

Cash and cash equivalents at beginning of period                                               66,253          89,239

Cash and cash equivalents at end of period                                               $     46,315       $  65,099
                                                                                         ===============    =============
Noncash investing and financing activities:

 Reclassification of equipment to inventory                                              $          -       $     556
                                                                                         ===============    =============
 Equipment acquired under capital lease obligations                                      $          -       $   2,120
                                                                                         ===============    =============
 (Decrement)/Accretion of redeemable warrants                                            $     (1,896)      $   4,478
                                                                                         ===============    =============
See accompanying notes to interim condensed consolidated financial statements.
</TABLE>

                                       3
<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 leading provider of digital
video-on-demand products and services. The Company was in the development stage
from July 1, 1995 (inception) to September 30, 1999. As of October 1, 1999, the
Company commenced principal operations, which consists of selling, licensing,
manufacturing and providing operational support for its video-on-demand products
and services.

     The interim unaudited financial statements as of March 31, 2001, and for
the three and nine months ended March 31, 2001 and 2000 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
44,349,330 shares of common stock) have 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 navigator applications and selected content and
operational services. The Company recognizes revenue in accordance with the
American Institute of Certified Public Accountants Statement of Position 97-2
(SOP 97-2), "Software Revenue Recognition," and Statement of Position 98-9
(SOP 98-9), "Software Revenue Recognition, with Respect to Certain
Transactions." SOP 97-2 generally requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair values of the elements. The fair value of an element must
be based on vendor specific objective evidence, which is generally determined by
the price charged when the element is sold separately. SOP 98-9 requires
recognition of revenue using the residual method in a multiple element


                                       4
<PAGE>

arrangement when fair value does not exist for one or more of the delivered
elements in the arrangement. Under the residual method, revenue for the
undelivered elements is deferred and subsequently recognized in accordance with
SOP 97-2.

     Prior to January 1, 2001, all hardware and software elements were
deliverable over the term of the contract and evidence of the fair value of the
individual elements in the Company's agreements did not exist. As a result, upon
the delivery of the Company's video-on-demand hardware products, revenue was
recognized to the extent of the cost of these hardware products. Any remaining
product revenue was amortized on a straight-line basis over the remaining term
of the agreement. The Company recognized license revenues over the term of the
agreement based on the number of subscribers.

     All of the Company's installations since January 1, 2001 have been made
under agreements whereby all hardware and software elements are delivered upon
completion of installation of the equipment and the training of cable network
personnel. Accordingly, for the three months ended March 31, 2001, the Company
recognized product revenue and licensing revenue upon completion of the
equipment installation at a customer's site, which included technical training,
according to the residual method. Consequently, the fair value of the
maintenance element, determined by the maintenance renewal fee, is deferred and
amortized over the maintenance period, which is generally one year.

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

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

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 nine months ended March 31,
2001 and 2000 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 products and services.
We have commercially deployed our video-on-demand service with several cable
operators in North America.



                                       5
<PAGE>

Our video-on-demand service operates on industry-standard digital set-top boxes
and operating systems and provides flexible and cost-effective interactive
television solutions for cable and other broadband operators, which we refer to
as network operators. In addition, we recently developed and beta tested an
interactive program guide. To date, we have not commercially deployed our
interactive program guide with any network operator. As a result, we are
currently evaluating the commercial viability of our interactive program guide
technology in today's market environment.

     Since our inception, we devoted substantially all of our resources to
developing our video-on-demand and other interactive products and services,
establishing industry relationships, carrying out marketing activities,
negotiating deployment agreements and establishing the operations necessary to
support the commercial deployment of our video-on-demand products and services.

     Through March 31, 2001, we generated minimal revenues and incurred
significant losses and substantial negative cash flow, primarily due to
engineering and development expenditures and other costs required to develop our
video-on-demand products and services. Since our inception through March 31,
2001, we have an accumulated deficit of $419.4 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 platform; licensing revenue resulting
from the licensing of our system software and navigator applications; and
service revenue resulting from programming services and operations support
services.

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

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



                                       6
<PAGE>

straight-line basis over the remaining term of the agreement. We recognized
license revenues over the term of the agreement based on the number of
subscribers.

     All of our installations since January 1, 2001 have been made under
agreements whereby all hardware and software elements are delivered upon
completion of installation and the training of cable network personnel.
Accordingly, for the three months ended March 31, 2001, we recognized product
revenue and licensing revenue upon completion of the equipment installation at a
customer's site, which includes technical training, according to the residual
method. Consequently, the fair value of the maintenance element, determined by
the maintenance renewal fee, is deferred and amortized over the maintenance
period, which is generally one year.

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

Operating Expenses

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

     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 systems. 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 products and services.*

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



                                       7
<PAGE>

     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. We expect that direct marketing costs will not represent a
significant component of total sales and marketing expense, as most network
operators will take responsibility for marketing video-on-demand services to
their subscribers.* To the extent we provide these services, they will likely
be performed under individual service agreements with the network operators and,
accordingly, the related expenses will fluctuate with revenues. Our future sales
and marketing costs will consist primarily of market development and product
management expenses.*

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

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

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

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

Other Income and Expense

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



                                       8
<PAGE>

Results of Operations

Revenue

     Revenue for the three months ended March 31, 2001 was $7.0 million compared
to $584,000 for the three months ended March 31, 2000. Total revenue for the
nine months ended March 31, 2001 was $8.4 million, compared to $1.7 million for
the nine months ended March 31, 2000.

     Product revenue. Product revenue for the three months ended March 31, 2001
and March 31, 2000 was $4.5 million and $436,000, respectively. Product revenue
for the nine months ended March 31, 2001 and March 31, 2000 was $4.6 million and
$1.4 million, respectively. The increase in product revenue for the three and
nine month periods ending March 31, 2001 is a result of a significant increase
in the number of system deployments, which occurred primarily during the quarter
ended March 31, 2001. Product revenue recognized for the nine months ended March
31, 2000 was related to older generation hardware, which has since been
discontinued.

     License revenue. License revenue for the three months ended March 31, 2001
and March 31, 2000 was $1.9 million and $16,000, respectively. License revenue
for the nine months ended March 31, 2001 and March 31, 2000 was $2.0 million and
$16,000, respectively. License revenue is the fee for our system manager
software and our navigator applications. The increase in license revenue for the
three and nine month periods ending March 31, 2001 is a result of a significant
increase in the number of system deployments during the third quarter.

     Service revenue. Service revenue was $583,000 and $132,000 for the three
months ended March 31, 2001 and 2000, respectively. Service revenue was $1.9
million and $303,000 for the nine months ended March 31, 2001 and 2000,
respectively. This increase in service revenue for the nine months ending March
31, 2001 was primarily due to the recognition of $589,000 of revenue resulting
from an adaptive engineering agreement with a network operator and an increase
in subscribers under revenue sharing arrangements.

Operating Expenses

     Cost of Revenue. Cost of revenue was $6.7 million and $2.6 million for the
three months ended March 31, 2001 and 2000, respectively. Cost of revenue was
$7.4 million and $3.7 million for the nine months ended March 31, 2001 and 2000,
respectively. The increase in the cost of revenue for the three and nine month
periods ending March 31, 2001 resulted from increased sales volume of our video-
on-demand products, software and services. The three and nine month periods
ended March 31, 2001 also included a charge for excess and obsolete inventory of
$1.2 million and $1.5 million, respectively.

     Programming. Programming expense was $1.4 million and $1.0 million for the
three months ended March 31, 2001 and 2000, respectively. Programming expense
was $3.4 million and $3.2 million for the nine months ended March 31, 2001 and
2000, respectively. The increase in programming expense for the three and nine
month periods ending March 31, 2001 was primarily attributable to an increase in
subscribers and in the acquisition of new titles.



                                       9
<PAGE>

     Operations. Operations expense was $1.3 million and $1.7 million for the
three months ended March 31, 2001 and 2000, respectively. The decrease in
operations expense for this period was due primarily to the allocation of
certain costs related to the manufacturing of our video-on-demand hardware
products. Operations expense was $4.9 million and $4.7 million for the nine
months ended March 31, 2001 and 2000, respectively. The increase in operations
expense for this period was primarily attributable to increased personnel costs
as we commercially introduced our video-on-demand products and services in
multiple network operators' plants.

     Engineering and Development.  Engineering and development expense was $9.3
million and $7.5 million for the three months ended March 31, 2001 and 2000,
respectively. Engineering and development expense was $24.9 million and $19.7
million for the nine months ended March 31, 2001 and 2000, 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 nine
months ended March 31, 2001 and 2000 was $2.2 million and $1.1 million,
respectively, in development related expenses pursuant to a development contract
with a third party. Engineering and development expenses for the three months
ended March 31, 2001 include charges for obsolete assets of approximately $1.5
million related to our VOD products and $1.8 million related to our interactive
program guide. For the nine months ended March 31, 2001, engineering and
development expense includes charges for obsolete assets of approximately $2.4
million related to our VOD products and $2.6 million related to our interactive
program guide.

     Sales and Marketing. Sales and marketing expense was $1.9 million and $1.6
million for the three months ended March 31, 2001 and 2000, respectively. Sales
and marketing expense was $5.2 million and $4.9 million for the nine months
ended March 31, 2001 and 2000, respectively.

     General and Administrative. General and administrative expense was $4.8
million and $5.8 million for the three months ended March 31, 2001 and 2000,
respectively. The decrease in general and administrative expense was
attributable to rental income in connection with the sublease of a portion of
our corporate headquarters to a third party. General and administrative expense
was $16.4 million and $14.5 million for the nine months ended March 31, 2001 and
2000, 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 increased patent and
legal expenses and professional services expenses related to the filing of a
registration statement on Form S-1, which was never declared effective, and an
increase in expenses associated with our United Kingdom subsidiary.

     Depreciation and Amortization.  Depreciation and amortization expense was
$1.4 million and $2.1 million for the three months ended March 31, 2001 and
2000, respectively. Depreciation and amortization expense was $4.5 million and
$5.4 million for the nine months ended March 31, 2001 and 2000, respectively.
The decrease in depreciation and amortization expense for the three and nine
month periods ending March 31, 2001 is attributable to the increase in fully
depreciated assets.

     Amortization of Deferred Stock Compensation.  Amortization of deferred
stock compensation expense was $801,000 and $1.3 million for the three months
ended March 31, 2001 and 2000,



                                      10
<PAGE>

respectively. The decrease in deferred stock compensation expense was partly
related to cancellations of stock grants from prior periods. Amortization of
deferred stock compensation expense was $3.0 million and $1.6 million for the
nine months ended March 31, 2001 and 2000, respectively. 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 $1.0 million and $1.4 million for the three months
ended March 31, 2001 and 2000, respectively. Interest income was $3.1 million
and $4.5 million for the nine months ended March 31, 2001 and 2000,
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 $24.4 million for the nine months ended March 31, 2001. 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 $11.3 million and $9.9 million for the three months ended March 31, 2001 and
2000, respectively. Interest expense was $27.6 million and $28.7 million for the
nine months ended March 31, 2001 and 2000, respectively. Included in interest
expense for the nine months ended March 31, 2001 is a gain on the revaluation of
redeemable put warrants of $4.7 million due to a lower estimated fair market
value of our common stock.

Provision for Income Taxes

     We have not provided for or paid federal income taxes due to our net
losses. As of June 30, 2000, we had net operating loss carry forwards 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 March 31, 2001, we have financed our operations
primarily through the gross proceeds of private placements totaling
approximately $108.3 million of equity and $250.0 million of high yield debt
securities. At March 31, 2001, we had cash and cash equivalents and short-term
investments totaling $57.4 million.

     Our cash and cash equivalents and short-term investments have decreased
from $76.8 million at December 31, 2000 to $57.4 million at March 31, 2001.
During the three-month period ending March 31, 2001, we took several actions to
address our declining cash position, including a 15% headcount reduction in our
workforce. We are contemplating additional measures to reduce our operating
expenses and working capital requirements on a going forward basis; however,
there can be no assurance that such actions can be implemented or, if
implemented, will be successful. In addition, we have arranged a meeting with
the holders of our senior discount notes to apprise them of our results for


                                      11
<PAGE>

the three month period ending March 31, 2001 and respond to inquiries from
certain noteholders by suggesting that they organize into an appropriate group
to facilitate a dialogue with us concerning the senior discount notes.

     On February 19, 1998, we received $250.0 million in gross proceeds from an
offering of 463,000 units consisting of senior discount notes with an aggregate
principal amount at maturity of $463.0 million and warrants to purchase an
aggregate of 2,778,000 shares of common stock. The net proceeds from the
offering of the notes were approximately $199.9 million, after deducting
placement fees and other offering costs, the extinguishment of all the
subordinated discount notes issued in a previous offering and a premium paid in
connection with the early extinguishment of these notes. In connection with the
offering, we allocated approximately $18.1 million of the proceeds to the
warrants.

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

     The indenture governing our senior discount notes imposes operating and
financial restrictions on 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 have limited our ability to perform certain activities in the
past and may limit our ability to finance our operations or engage in other
business activities that may be in our best interest in the future.

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

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

     We believe our cash, cash equivalents and short-term investments will be
sufficient to satisfy our cash requirements through September 30, 2001.*
Thereafter, we will need to raise significant additional funds to support our
operations by raising debt or equity financing, selling assets, or entering into
strategic relationships, and there can be no assurance that we will be able to
perform any of the foregoing on favorable terms, or at all, particularly given
the current unfavorable financial market environment.* We may also need to
raise significant additional funds in order to respond to




                                      12
<PAGE>

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. 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,
including, potentially, ceasing certain of our operations in an effort to reduce
our cash requirements. Failure to successfully address our ongoing liquidity
requirements could have a material adverse effect upon our business. 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 our securities portfolio.*

     Our short-term investments have generally been available-for-sale. Gross
unrealized gains and losses were not significant as of March 31, 2001.

     The following table presents the principal amounts and related weighted-
average yields for our fixed rate investment portfolio (in thousands, except
average yields) at March 31, 2001.

<TABLE>
<CAPTION>
                                             Carrying  Average
                                              Amount    Yield
                                             --------  --------
<S>                                          <C>       <C>
U.S. government obligations                   $25,731     5.32%
Commercial paper                               23,180     5.25%
Certificates of deposits                        2,152     4.57%
Money market instruments                          775     5.60%
Auction rate preferred stock certificates       5,600     5.24%
                                              -------     ----
          Total                               $57,438
                                              =======

Included in cash and cash equivalents          46,315
Included in short-term investments             11,123
                                              -------
          Total                               $57,438
                                              =======
</TABLE>



                                      13
<PAGE>

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 $61,000.

Factors Affecting Operating Results

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, licensing and provisioning of our video-on-demand products
and services and, commencing on September 1, 2003, to make cash interest
payments on our indebtedness. We have made and expect to continue to make
significant investments in working capital in order to fund development
activities, sell our video-on-demand products and services and fund operations.
We expect to continue to incur significant operating losses and expect that our
operating cash flow will be negative for at least the next few years. We believe
our cash, cash equivalents and short-term investments will be sufficient to
satisfy our cash requirements through September 30, 2001.* Thereafter, we will
need to raise significant additional funds to support our operations by raising
debt or equity financing, selling assets, or entering into strategic
relationships, and there can be no assurance that we will be able to perform any
of the foregoing on favorable terms, or at all, particularly given the current
unfavorable financial market environment.* 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.
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, including, potentially, ceasing certain of our operations in an
effort to reduce our cash requirements. Failure to successfully address our
ongoing liquidity requirements could have a material adverse effect upon our
business. We may also not be able to pay interest and principal on our
indebtedness when due.



                                      14
<PAGE>

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

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

     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 have arranged a meeting
with the holders of our senior discount notes to apprise them of our results for
the three month period ending March 31, 2001 and respond to inquiries from
certain noteholders by suggesting that they organize into an appropriate group
to facilitate a dialogue with us concerning the senior discount notes. 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 or other successful attempts to raise cash such as the
sale of assets or equity or debt financing, we likely would not be able to
service our indebtedness.

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

     We are highly leveraged. As of March 31, 2001, we had senior discount notes
payable of approximately $344.2 million. The senior discount notes accrete at
the rate of 12 5/8% per annum, compounded semi-annually. The senior discount
notes were sold at a significant discount and must be repaid at maturity on
March 1, 2008 at the aggregate par value of $463.0 million. The degree to which
we are leveraged could have important consequences to us and our investors,
including, but not limited to, the following:

 .  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



                                      15
<PAGE>

 .  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.

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

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

     We are an early stage company with limited commercial operating history. We
have generated revenues of approximately $10.8 million and have incurred net
losses of $419.4 million since our inception through March 31, 2001. We expect
to continue to incur substantial losses and experience substantial negative cash
flow for at least the next few years as we continue to develop our operations
capability and sell and license our 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 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 the sale and license 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;


                                      16
<PAGE>

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

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

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

 .  our ability to continue technical development of our video server, our access
   equipment, our service software and our other video-on-demand system
   components in order to reduce their manufacturing cost and enhance their
   functionality; 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 revenues, and we have limited
meaningful historical financial data on which to base planned operating
expenses. We are unable to accurately forecast our revenues because:

 .  we participate in an emerging market;

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

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

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

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

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

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

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



                                      17
<PAGE>

 .  the timing of deployments by network operators of our interactive products
   and services;

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

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

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

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

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

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

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

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

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



                                      18
<PAGE>

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

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

     Our video-on-demand service requires 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. 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 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.



                                      19
<PAGE>

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

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

Our lengthy sales cycle may cause fluctuations in our operating results

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

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

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

 .  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.


                                      20
<PAGE>

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

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

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

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

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

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

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

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



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<PAGE>

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 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.

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

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

     Parties making claims of infringement may be able to obtain injunctive or
other equitable relief that could effectively block our ability to provide our
products and services in the United States and internationally and could result
in an award of substantial damages. In the event of a successful claim of
infringement, 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
products or services, any of which could harm our business.



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<PAGE>

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

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

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

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

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

     In those network operator deployments where we provide programming content,
our success will depend, in part, on our ability to obtain access to sufficient
movies (including new releases and library titles), special interest videos and
other programming content on commercially acceptable terms. Although we have
entered into arrangements with major movie studios and other content providers,
we may not be able to continue to obtain the content. In addition, for content
we do procure, we may not be able to make the content available to video-on-
demand customers during the segment of time available to other video-on-demand
providers and to programmers such as pay-per-view providers. Studios may require
us to make prepayments prior to the time that customers pay for viewing a title
or require us to enter into long-term contracts with significant minimum
payments. Further, studios may increase the license fees currently charged to
us. If we are unable to obtain timely access to content on commercially



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<PAGE>

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

     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 manage our international growth successfully could result in higher operating
costs than anticipated, or could delay or preclude our ability to generate
revenues in key international markets.


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<PAGE>

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 62.1% of our outstanding Common Stock (assuming
conversion of all outstanding Preferred Stock into Common Stock) at March 31,
2001. Accordingly, these stockholders have significant influence over our
affairs. This concentration of ownership could have the effect of delaying or
preventing a change in control of DIVA.



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<PAGE>

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 March 31, 2001, we issued and sold an
aggregate of 178,708 shares of Common Stock to our employees and consultants for
an aggregate purchase price of $114,935 pursuant to exercises of options under
our 1995 and 1998 Stock Plans. In addition, during the three months ended March
31, 2001, we issued and sold 249 shares of Series AA Preferred Stock for an
aggregate purchase price of $93. These issuances were deemed exempt from
registration under the Securities Act of 1933, as amended, in reliance upon Rule
701 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 March 31, 2001.



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<PAGE>

                                   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: May 3, 2001




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