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SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT
TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(MARK ONE)

/x/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MAY 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 NUMBER 000-26565

LIBERATE TECHNOLOGIES

(Exact Name of Registrant as Specified in Its Charter)

DELAWARE

94-3245315(State or Other Jurisdiction of Incorporation or Organization)

(I.R.S. Employer Identification No.)2 Circle Star Way, San Carlos, California

94070-6200(Address of Principal Executive Offices)

(Zip Code)


(650) 701-4000Registrant's Telephone Number, Including Area Code

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, $0.01 PAR VALUE PER SHARE
(Title of Class)

Indicate by check mark whether the Company (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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes /x/    No / /

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

As
of July 31, 2001, the aggregate market value of the voting stock held by non-affiliates of the Company was $862,131,000 based on the last reported sale price of
the Company's common stock on the Nasdaq National Market System, and there were 105,209,957 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on October 30, 2001 are incorporated
by reference in Items 10, 11, 12, and 13 of Part III of this Report.

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LIBERATE TECHNOLOGIES  ANNUAL REPORT ON FORM 10-K  FOR THE FISCAL YEAR ENDED MAY 31, 2001    TABLE OF CONTENTS

|                                           |          |    |                                                                                       | Page
|------------------------------------------ | -------- | -- | ------------------------------------------------------------------------------------- | ----
|                                           |          |    |                                                                                       |     
|PART I                                     |          |    |                                                                                       |     
|                                           | Item 1.  |    | Business                                                                              |     
|                                           | Item 2.  |    | Properties                                                                            |     
|                                           | Item 3.  |    | Legal Proceedings                                                                     |     
|                                           | Item 4.  |    | Submission of Matters to a Vote of Security Holders                                   |     
|                                           | Item 4a. |    | Executive Officers                                                                    |     
|                                           |          |    |                                                                                       |     
|PART II                                    |          |    |                                                                                       |     
|                                           | Item 5.  |    | Market for Registrant's Common Equity and Related Stockholder Matters                 |     
|                                           | Item 6.  |    | Selected Financial Data                                                               |     
|                                           | Item 7.  |    | Management's Discussion and Analysis of Financial Condition and Results of Operations |     
|                                           | Item 7a. |    | Quantitative and Qualitative Disclosures About Market Risk                            |     
|                                           | Item 8.  |    | Financial Statements and Supplementary Data                                           |     
|                                           | Item 9.  |    | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |     
|                                           |          |    |                                                                                       |     
|PART III                                   |          |    |                                                                                       |     
|                                           | Item 10. |    | Directors and Executive Officers of the Registrant                                    |     
|                                           | Item 11. |    | Executive Compensation                                                                |     
|                                           | Item 12. |    | Stock Ownership of Certain Beneficial Owners and Management                           |     
|                                           | Item 13. |    | Certain Relationships and Related Transactions                                        |     
|                                           |          |    |                                                                                       |     
|PART IV                                    |          |    |                                                                                       |     
|                                           | Item 14. |    | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |     
|Signatures                                 |          | 44
|Index to Consolidated Financial Statements |          | 45

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PART I

ITEM 1. BUSINESS

The discussion in this Report on Form 10-K ("Form 10-K") contains forward-looking statements that involve risks and
uncertainties. Any statements in this document that are not statements of historical fact, including statements of our expectations, beliefs, intentions, or strategies regarding the future are
forward-looking statements within the meaning of the securities laws of the United States, and are subject to the safe harbor created by those laws. In some cases, you can identify forward-looking
statements by words such as "may," "will," "should," "expect," "plan," "anticipate," "intend," "believe," "estimate," "predict," "potential," or "continue." These statements are only predictions, not
guarantees. Also note that the statements are based on information currently available to us, and we assume no obligation to update them. Actual results may differ materially from those projected in
forward-looking statements due to factors that include, but are not limited to, our new and emerging market, limited availability of technology and services necessary for interactive television
systems and consumer device networks, dependence on a limited number of network operators and consumer device manufacturers, uncertain macroeconomic conditions, limited operating history and history
of losses, fluctuations in quarterly operating results, reliance on international revenues, competition, potential problems with our software, litigation, and other risks outlined under Part I
"Business-Risk Factors" or detailed from time to time in our reports and registration statements filed with the Securities and Exchange Commission. You should consider our forward-looking
statements in conjunction with our financial statements, related notes, and the other financial information appearing elsewhere in this Form 10-K.

Overview

Liberate Technologies, also referred to as "Liberate," "we," or "us," is the premier provider of standards-based software platforms for delivering enhanced
content and services to television viewers and consumers around the world. Network operators (such as cable and satellite television operators and telecommunications companies), broadcasters, content
providers, and manufacturers of information-oriented consumer devices such as television set-top boxes, and game consoles ("consumer devices") are able to use our software to deliver
enhanced content and services. Our software enables a wide variety of third-party applications to function across different information networks and different types of consumer devices. We are also
developing a number of extensions to our software platform to facilitate the management of networks. To extend the functionality of our software platform, we have developed strategic alliances with
leading technology vendors such as Cisco Systems, Concurrent,
DIVA, Motorola (which acquired General Instrument in January 2000), Nagravision, NDS, Pace Micro Technology, Scientific-Atlanta, and Sun Microsystems. We also have established commercial or
strategic relationships with large network operators, such as AOL Time Warner, Comcast Cable Communications, Cox Communications, iesy (eKabel), Insight Communications, NTL Group, Optus Vision
Interactive, Telewest Communications, and United Pan-Europe Communications (UPC).

We
began our operations in late 1995 as a division of Oracle, developing client and server software for the consumer, enterprise, and educational markets. We incorporated in Delaware
in April 1996 when Oracle spun off that division as Network Computer, Inc., also referred to as NCI. NCI's initial focus was on selling software to original equipment manufacturers of
network computer products for enterprise customers. In August 1997, NCI merged with a Netscape Communications subsidiary, Navio Communications, Inc., also referred to as Navio, which was
developing Internet application and server software for the consumer market. NCI was the surviving entity in the merger. After the merger, we changed our strategic direction and restructured our
operations to focus our development and marketing efforts on products targeted primarily at the consumer device market, targeting sales to a limited number of large network operators and consumer
device manufacturers. On May 11, 1999, we changed our name from NCI to Liberate Technologies.

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Since our incorporation, we have raised a significant amount of capital by selling small equity positions to a number of investors, including some major network operators. This has
provided us with the financial resources we needed to continue our growth, given us resources to pursue investments and acquisitions, and reinforced our relationships with participating network
operators. In order to continue to fund our growth, we decided to offer our stock to the public and become a publicly traded company on July 28, 1999. In January 2000, we effected a
two-for-one split of our stock. We raised additional capital in February 2000 by commencing a secondary public offering, and again in July 2000 when Cisco Systems
invested $100.0 million through a private placement.

We
have made two acquisitions since becoming a publicly traded company. In March 2000, we acquired the VirtualModem assets of SourceSuite LLC, also referred to as SourceSuite,
a company based in Canada. In June 2000, we acquired MoreCom, Inc., also referred to as MoreCom, based in Horsham, Pennsylvania.

We
currently generate revenues by licensing our client and server products, applications, and tools and by providing related services, largely to network operators (primarily
providers of television services) and consumer device manufacturers (primarily set-top box manufacturers). In addition, we generate revenues from consulting, maintenance, and other
services provided in connection with client and server licenses.

Our
fiscal year runs from June 1 to May 31, with each fiscal year ending on May 31 of the corresponding calendar year. We operate solely in one
segmentproviding software and services to a broad range of consumer devices, primarily cable and satellite set-top boxes. Our stock is traded on the Nasdaq National Market
under the symbol "LBRT" and there were 105,209,957 million shares of stock outstanding as of July 31, 2001.

We
have offices in North America, Europe, and Asia. Our headquarters and primary development offices are located in San Carlos, California. We have development offices in Murray City,
Utah; Horsham, Pennsylvania; and London, Ontario, Canada. We also have sales offices in London, England and Tokyo, Japan.

Products and Technology

Our software platform includes a full range of client and server products, tools, and applications. We offer network operators a suite of server solutions
tailored to the cable, satellite, digital terrestrial, and telecommunications markets. We deliver client products targeted for the needs of consumer device manufacturers, with a current focus on
television set-top boxes. Our tools and pre-configured applications allow network operators and consumer device manufacturers to offer a fully customizable client and server
platform.

Our
client and server software platform extends a standards-based framework with proprietary technology that we have developed to address the specific needs of network operators and
consumer device manufacturers, including the following technologies:



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The
following table provides a list of our principal products and a brief description of their features and benefits.

|Selected Products               |  | Selected Features & Benefits                                                                                                                                                                              
|------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Liberate® Connect Suite Server |  |  Subscriber and application management. Control of subscriber access to applications and services and access to subscriber data for efficient customer support.                                          
|                                |  |  Internet-standard security. Secure transactions for personal information and e-commerce.                                                                                                                
|                                |  |  Open integration interfaces. Close integration of our servers with existing subscriber management, database, and billing systems.                                                                       
|                                |  |  Device management tools. Automatic and efficient distribution of software updates to all network devices and rapid restoration of services in case of client or network failure.                        
|                                |  |  Highly scalable architecture. Ability to scale networks to support millions of subscribers by simply installing more servers on the system.                                                             
|Liberate® Mediacast Server     |  |  Content and application broadcasting. Broadcast of Internet content and interactive applications using existing network infrastructure.                                                                 
|                                |  |  Multiple transport stream capability. Transmission of data over different networks, permitting fuller use of infrastructure.                                                                            
|Liberate® Transcoder Server    |  |  Reduced processing and memory requirements. Delivery of rich Internet content and applications to a broad range of consumer devices.                                                                    
|                                |  |  Internet content error-checking. Accurate rendering of HTML, image, and audio content.                                                                                                                  
|Liberate® Datapoint Server     |  |  Ability to store consumer and set-top box related information. Ability to store users' service and applications preferences on the headend; ability to store key technical data on users' set-top
boxes.
|                                |  |  Scalable database. Use of database architecture to ensure scalability and reliability of the architecture in volume deployments.                                                                        

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|Liberate® Command Server                       |  |  Internet interface for server and applications management. Management and monitoring of all our server systems and applications throughout a network from any Internet-connected workstation.                                                                                                               
|----------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Liberate® Imprint Server                       |  |  Client/server application for user preference analysis. Ability to gather usage information to enable enhanced personalization.                                                                                                                                                                             
|Liberate® TV Info
Infrastructure Application   |  |  XML-based architecture for receiving, integrating, and exporting multiple TV and other data streams to multiple clients and applications. Combination and delivery of TV programs and other data to various
applications, including interactive program guides, channel bars, and pay-per-view applications.
|Liberate® TV Ticker
Infrastructure Application |  |  Continuous information delivery, such as interactive news, sports statistics, and stock quotes. Delivery of real-time information to consumers via client- and server-based applications.                                                                                                                   
|Liberate® TV Mail
Infrastructure Application   |  |  TV-based e-mail application. Customized e-mail services using existing infrastructure.                                                                                                                                                                                                                      
|                                                |  |  Picture and video e-mail. Delivery of rich multimedia content that enhances the e-mail experience.                                                                                                                                                                                                          
|Liberate® TV Chat
Infrastructure Application   |  |  Integration of online discussion with TV programming. Promotion of subscriber communities by supplementing existing TV programming with interactive online discussion capabilities.                                                                                                                         
|Liberate® TV Navigator
Standard Client         |  |  Small (700Kb) memory requirement. Reduced memory and processing component costs, and ability to run software on memory-constrained devices, including digital set-top boxes.                                                                                                                                
|                                                |  |  Integrated video and data path. Use of existing high-bandwidth video delivery systems to deliver Internet-based interactive television content and applications, such as TV-based browsers and
e-mail.                                                                                                      
|                                                |  |  HTML and JavaScript support. Delivery of Internet standards-based applications, content, and services to customers.                                                                                                                                                                                         
|                                                |  |  Portability. Easy integration with a variety of existing and next-generation set-top boxes.                                                                                                                                                                                                                 
|                                                |  |  Customizable user interface. Ability to brand and control the user interface associated with the service and applications offered.                                                                                                                                                                          
|                                                |  |  Multiple network architectures. Compatibility with infrastructure of cable and satellite television, broadband telecommunications (using DSL-based networks), and digital terrestrial services.                                                                                                             
|Liberate® TV Navigator
Compact Client          |  |  Small memory requirements (starting at 300Kb), capability to run with less than 10 MIPS of CPU performance. Delivery of interactive services to set-top boxes that have memory and processor
constraints.                                                                                                   
|                                                |  |  Liberate microVM application engine support (a subset of the Java application environment; certification pending). Use of the rich Java language for authoring and portability purposes.                                                                                                                    
|                                                |  |  Headend-based transcoding. Use of existing content development tools to build interactive applications.                                                                                                                                                                                                     

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|Liberate® TV Producer Tools   |  |  Tools and tutorials for creating applications. Rapid creation of content and applications targeted to a television audience, using open-standards authoring and the Liberate microVM application
environment.                                         
|------------------------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Liberate® TV Emulator Tools   |  |  Real-time client emulator running on the Windows platform. Inexpensive design and testing of applications without a full broadcast-enabled environment.                                                                                               
|                               |  | Suite of integrated debugging tools. Ability to debug developed code in an easy-to-use development environment.                                                                                                                                        
|Liberate® TV Customizer Tools |  |  Easy modification of the look and feel of the resident applications and key client-side service utilities. Ability to create a consistent and customized look and brand across a network operator service that
expands the usefulness of key services.
|Liberate® TV Porter Tools     |  |  Tools for porting the Liberate TV Navigator client to new or existing set-top boxes. Development and delivery of drivers compliant with the Liberate Porting API.                                                                                     
|                               |  |  Sample drivers developed in the course of a porting project. Availability of a wide choice of our enabled set-top boxes that result in lower hardware costs and accelerate volume deployments.                                                        

Liberate®,
the Liberate logo, and various Liberate products and programs are registered trademarks and trademarks of Liberate Technologies. All other trademarks are the property of their
respective owners.

Services

We provide our customers a comprehensive set of consulting, maintenance, and other services.

Consulting services.As of May 31, 2001, our consulting services groups consisted of 93 full-time
employees. These groups provide project management support, which includes implementation guidance, product customization, and product configuration support. These groups also provide project
management, engineering assistance, and assistance with custom application development. To help ensure seamless product deployments, these groups may work closely, often onsite, with network operators
and consumer device manufacturers to integrate and install our software.

Maintenance and other services.As of May 31, 2001, our customer service, support, and training organizations
consisted of 29 full-time employees that provide worldwide support and services. We run a
technical training program for our worldwide customers and developers. Curriculum and training classes are available for most of our products.

Research and Development

As of May 31, 2001, our research and development organization consisted of 284 full-time employees. We have development offices in San
Carlos, California; Murray City, Utah; Horsham, Pennsylvania; and London, Ontario, Canada. Our total research and development expenses were $18.2 million, $32.3 million, and
$51.2 million for fiscal 1999, 2000, and 2001, respectively. These amounts exclude acquisition-related charges for purchased in-process research and development of
$1.9 million in 2000 and $22.4 million in 2001. We believe our success will depend in part upon our ability to continue to invest in research and development. We intend to continue to
devote substantial

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resources to improving our full range of product offerings (including offering higher levels of integration among our products) and introducing new products and services.

Sales and Marketing

We license our server software directly to network operators and license our client software to both consumer device manufacturers and network operators.
Consumer devices containing our software platform are distributed by the manufacturer to the end user either through network operators or retail channels.

We
license our software primarily through our direct sales force. We use indirect resellers in certain developing markets and may increase the number of indirect distribution partners
in the future. Our sales force, which consisted of 36 individuals as of May 31, 2001, is organized into teams of sales representatives and systems engineers. As of May 31, 2001, direct
sales professionals were located in North America, Europe, and Asia. We use our direct sales force to target the customers who we believe provide the highest potential for service deployment and
revenues.

To
complement our direct sales and distribution efforts, our marketing department seeks to identify customer needs, design products, and stimulate demand. Our marketing department
coordinates our participation in tradeshows worldwide, arranges speaking engagements for key personnel, sponsors conferences, and runs a program for developers. An internal creative production group
supports the marketing effort by helping to define the next generation of interfaces for our products. We gather actual consumer and usage feedback, based on our current deployments, to direct the
development of future products and enhancement of current products. During fiscal 2000, we launched our PopTV
Program, a partner program for interactive television that includes content creators, infrastructure providers, and hardware suppliers.

Customers

Our customers are typically large network operators who introduce, market, and promote products and services based on our technology. For fiscal 1999, our four
largest customers accounted for 52% of our total revenues, with Wind River Systems accounting for 23% of total revenues and NTL accounting for 15% of total revenues. For fiscal 2000, our five largest
customers accounted for 54% of our total revenues, with NTL accounting for 21% of total revenues and Wind River Systems accounting for 15% of total revenues. For fiscal 2001, our four largest
customers accounted for 54% of our total revenues, with NTL accounting for 21% of total revenues and Telewest Communications accounting for 19% of total revenues. The percentages for NTL include
amounts previously reported for Cable and Wireless Communications. In May 2000, NTL acquired the consumer cable and certain other operations of Cable and Wireless. We expect that we will
continue to depend upon a limited number of customers for a significant portion of our revenues in future periods, although the specific customers may vary from period to period.

Competition

We face intense competition in licensing software for networks and consumer devices. Our principal competitors in the client software market include Microsoft,
OpenTV, Canal+ Technologies, and PowerTV. In the server market, our primary competitor is Microsoft. We also expect additional competition from other established and emerging companies in the
television, computer, software, and telecommunications sectors. The principal competitive factors in our industry are the quality and breadth of product and service offerings, the ease and speed with
which a product can be integrated into existing networks and deployed to customers, the efficiency with which software platforms operate with various consumer devices, customers' overall return on
investment, the efficient management of available bandwidth in the deployed networks, the possession of patents relating to important

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technologies, the adequacy of financial resources, the competitiveness of product pricing, the length of time to market, and the effectiveness of sales and marketing efforts. We believe that we
presently compete favorably with our competitors in many of these areas. However, the market for consumer devices is evolving, and we cannot be certain that we will compete successfully in the future.
See "Risk Factors-Competition From Bigger, Better Capitalized Competitors Could Result In Price Reductions, Reduced Gross Margins, And Loss Of Market Share."

Intellectual Property Rights and Proprietary Information

We have a portfolio of technologies and intellectual property that addresses various features of interactive networks and devices. We believe that significant
value lies in the intellectual property we have developed, acquired, and incorporated into our technologies and systems. Accordingly, we seek to protect and grow our intellectual property portfolio by
developing and acquiring strategically important technologies and patents. We safeguard our proprietary information and our other intellectual property through a combination of domestic and
international copyrights, trademarks, patents, and trade secret protection, as well as through contractual protections such as proprietary information agreements and nondisclosure agreements. However,
we cannot guarantee that these steps will deter misappropriation of our proprietary information, and we may not be able to detect unauthorized use and take appropriate steps to enforce our
intellectual property rights. See "Risk Factors-Our Limited Ability To Protect Our Intellectual Property And Proprietary Rights May Harm Our Competitiveness."

We
currently have over 30 issued U.S. patents in the general area of interactive networking technologies with more than 750 claims, and over 30 issued foreign patents. We continue to
develop new technologies and file a range of additional patent applications as part of a worldwide intellectual property program, and we currently have over 40 U.S. patent applications pending.

We
have registered "Liberate" and the Liberate logo in the United States and extensively throughout the world, and use our many other product trademarks in association with these
marks.

Employees

As of May 31, 2001, we had 520 employees, including 284 in engineering, 122 in services, 72 in sales and marketing, and 42 in administration. None of
our employees is represented by a collective bargaining agreement. We have never experienced a work stoppage and we consider our relations with our employees to be good.

Liberate Corporate Venture Fund

We launched the Liberate Corporate Venture Fund in November 2000 to promote the development of interactive television and spur the growth of innovative
companies. The Liberate Corporate Venture Fund operates as a business group within Liberate.

The
Venture Fund's approach is to identify promising privately held companies that are in the mid-to-late stages of financing, have exceptional management
teams, and have developed proven technologies. The fund seeks to aid the development of the interactive television industry and give us
insight into leading-edge technologies and services in the interactive television industry, while also providing reasonable financial returns. We also expect to develop mutually beneficial
commercial relationships with the companies in which we invest.

In
most cases, we plan to acquire a minority equity stake by co-investing with top-tier venture funds and do not intend to seek a seat on the portfolio
company's board of directors. Typically, the size of any investment will range between 15% and 25% of any given financing event. Given the appropriate opportunity, we may choose to invest outside
these parameters. As of May 31, 2001, we had invested $15.2 million in our portfolio of companies, then comprised of DIVA Systems, Everypath,

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ICE, MetaTV, and Two Way TV. In fiscal 2001, we wrote down $5.3 million of equity investments that had been permanently impaired, reducing our net equity investments to $9.9 million as
of May 31, 2001. See "Risk Factors-We May Not Be Successful in Making Strategic Investments" and Note 2 of Notes to Consolidated Financial Statements.

In
June 2001, we committed to invest $2.0 million in China Broadband (H.K.), for reinvestment in China New Broadband Video & Communication, a Chinese joint
venture that makes interactive television software.

Risk Factors

The discussion in this Form 10-K contains forward-looking statements that involve risks and uncertainties. Any statements in this document
that are not statements of historical fact, including statements on our expectations, beliefs, intentions or strategies regarding the future are forward-looking statements within the meaning of the
securities laws of the United States, and are subject to the safe harbor created by those laws. In some cases, you can identify forward-looking statements by words such as "may," "will," "should,"
"expect," "plan," "anticipate," "intend," "believe," "estimate," "predict," "potential," or "continue." These statements are only predictions based on information currently available to us. The
statements involve uncertainty and we cannot guarantee future results. We assume no obligation to update any forward-looking statements. Actual results may differ materially from those projected in
forward-looking statements due to factors that include, but are not limited to, our new and emerging market, limited availability of technology and services necessary for interactive television
systems and consumer device networks, dependence on a limited number of network operators and consumer device manufacturers, poor macroeconomic conditions, limited operating history and history of
losses, fluctuations in quarterly operating results, reliance on international revenues, competition, potential problems with our software, litigation, and other risks outlined under Part I
"Business-Risk Factors" or detailed from time to time in our reports and registration statements filed with the Securities and Exchange Commission. You should consider our forward-looking
statements in conjunction with our financial statements, related notes, and the other financial information appearing elsewhere in this Form 10-K.

Any
of the following risks could seriously harm our business, financial condition, and results of operations, causing the trading price of our common stock to decline.

Demand For Information-Oriented Consumer Devices And Interactive Television May Not Develop As We Anticipate.

Because the market for interactive television and information-oriented consumer devices (such as set-top boxes) is newly emerging, the potential
size of the market opportunity and the timing of its development are uncertain. As a result, our profit potential is unknown.

Sales
of our technology and services depend upon the commercialization and broad acceptance by consumers and businesses of interactive television and information-oriented devices,
primarily cable and satellite set-top boxes as well as networks of game consoles, smart phones, and personal digital assistants. This will depend in turn on many factors, including the
development of content and applications of interest to significant numbers of consumers, and the emergence of industry standards that facilitate the distribution of such content.

If
the market for interactive television consumer devices, and set-top boxes in particular, does not develop or develops more slowly than we anticipate, our revenues will
not grow as quickly as expected, if at all.

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Deployment And Availability Of Interactive Television And Consumer Device Networks May Be Limited By High Costs Or Limited Availability Of System Components.

Interactive television networks and other consumer-device networks are complex systems, requiring the successful interaction of many elements in order to be
technologically and financially attractive to deploy. Many network operators seek to deploy a complete interactive television system, including features such as video-on-demand
and guide services, rich content, and robust infrastructure support. Several vendors are typically involved in providing the content and applications that comprise a complete interactive television
system.

In
different regions of the world, certain elements of such systems may be controlled by a single company or a few large companies. For example, in the United States, one of the
largest potential
markets for interactive television, the manufacture of set-top boxes and ownership of cable networks are relatively concentrated. Development of the interactive television market may be
slowed if these companies do not participate in the deployment of interactive television, charge excessive fees, or do not adopt industry standards that permit interconnection and a uniform
environment for developing applications and content.

Moreover,
some companies have obtained patent protection on technology relating to important parts of a complete interactive television system. If patent licenses were required to
assemble a complete interactive television system and could not be obtained on reasonable terms, the development of the interactive television industry could be slowed and revenues available to other
participants in the market could be reduced.

Our Success Depends On A Limited Number Of Network Operators Introducing And Promoting Products And Services Incorporating Our Technology.

Our success depends on large network operators introducing and promoting products and services based on our technology. There are, however, only a limited
number of large network operators worldwide. Currently, only a limited number of these network operators are deploying products and services incorporating our technology and services for consumer
devices. In addition, none of our network operator customers is contractually obligated to introduce or promote products and services incorporating our technology, nor to achieve any specific
introduction schedule. Accordingly, even if a network operator initiates a customer trial of products incorporating our technology, that operator is under no obligation to continue its relationship
with us or to launch a full-scale deployment of these products. Further, our agreements with network operators are generally not exclusive, so network operators with whom we have
agreements may enter into similar license agreements with one or more of our competitors.

Because
the large-scale deployment of products and services incorporating our technology is complex, time-consuming, and expensive, network operators are cautious about
proceeding with such deployment. While we believe that products and services based on our technology will have significant value to network operators (in the form of opportunities to generate
additional revenues per subscriber from interactive applications, such as video-on-demand, and the loss of fewer subscribers to competing services), there is only limited data
available to demonstrate to network operators that they will receive attractive returns on their investments. Moreover, the customization process for new customers requires a lengthy and significant
commitment of resources by our customers and us. The commitment of resources required by our customers may slow deployment, which could, in turn, delay market acceptance of these products and
services. Also, many of our customers rely on debt-based financing and subscriber revenues to fund their deployments, so economic conditions that reduce either of these sources of
financing may slow deployment as well. Unless network operators introduce and promote products and services incorporating our technology in a successful and timely manner, our software

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platform will not achieve widespread acceptance, consumer device manufacturers will not use our software in their products, and our revenues will not grow as quickly as expected, if at all.

Our Success Depends On Consumer Device Manufacturers Introducing And Promoting Products That Incorporate Or Operate With Our Technology.

We do not typically manufacture hardware components that incorporate our technology. Rather, we license software technology to consumer device manufacturers
and work with them to ensure that our products operate together. Accordingly, our success will depend, in part, upon our ability to convince a number of consumer device manufacturers to manufacture
products that incorporate or operate with our technology and upon the successful introduction and commercial acceptance of these products.

While
we have entered into a number of agreements with consumer device manufacturers, none of these manufacturers is contractually obligated to introduce or promote consumer devices
incorporating our technology, nor are any of them contractually required to achieve any specific production schedule. Moreover, our agreements with consumer device manufacturers are generally not
exclusive, so consumer device manufacturers with whom we have agreements may enter into similar license agreements with one or more of our competitors. Our failure to convince consumer device
manufacturers to incorporate our software platform into their products or modify their products to operate with our software, or the failure of these products to achieve broad acceptance with
consumers and businesses, will result in our revenues not growing as quickly as expected, if at all.

A Continued Downturn In Macroeconomic Conditions Could Reduce Sales Of Our Products And Services.

U.S.
economic growth slowed significantly in the past several months. In addition, there is uncertainty relating to the prospects for near-term U.S. and international
economic growth. This slowdown and uncertainty may harm our business by reducing our customers' spending and the rate at which they accept our technology and services. In the future our operations may
experience substantial fluctuations from period to period as a consequence of general economic conditions affecting the timing of orders from major customers and other factors affecting capital
spending. There can be no assurance that these factors will not harm our business, financial condition, or operating results.

Our Limited Operating History Makes Evaluation Of Our Business Difficult.

We were incorporated in April 1996 and began shipping our initial products to customers in the last quarter of fiscal 1997. Our limited operating
history makes evaluation of our business and prospects difficult. In addition, any evaluation of our business and prospects must be made in light of the risks and unexpected expenses and difficulties
frequently encountered by companies in an early stage of development in a new market. For us, these risks include:



Many
of these risks are described in more detail elsewhere in this "Risk Factors" section. Our business could be seriously harmed by adverse developments in any of these areas.

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We Have A History Of Losses And Expect To Incur Losses In The Future.

We incurred net losses of $33.1 million for fiscal 1999, $80.8 million for fiscal 2000, and $306.4 million for fiscal 2001. Our net loss
for fiscal 1999 included amortization of purchased intangibles of $6.1 million. Our net loss for fiscal 2000 included amortization of purchased intangibles of $22.1 million, warrant
amortization of $10.8 million, and a $1.9 million charge for acquired in-process research and development related to the SourceSuite acquisition. Our net loss for fiscal 2001
included amortization of purchased intangibles of $216.1 million, warrant amortization of $23.2 million, and a $22.4 million charge for acquired in-process research
and development related to the MoreCom acquisition. As of May 31, 2001, we had an accumulated deficit of $536.9 million.

Since
our inception, we have not had a profitable quarter and may never achieve or sustain profitability. Although historically our revenues have increased every fiscal year, we may
not be able to sustain our historical revenue growth rates. We also expect that our costs of revenues and operating expenses will continue to increase. If we are to achieve profitability given our
planned expenditure levels, we will need to generate and sustain substantially increased license and royalty revenues from increased deployments and we may not be able to do so. See "Risk
Factors-Our Success Depends On A Limited Number Of Network Operators Introducing And Promoting Products And Services Incorporating Our Technology" and "Risk Factors-Our Success
Depends On Consumer Device Manufacturers Introducing And Promoting Products That Incorporate Or Operate With Our Technology." From the beginning of fiscal 1997 through May 31, 2001, 56% of our
revenues have been derived from services provided by us and not from license and royalty fees, as our customers have primarily been in the design and implementation phases with our products. We are
likely to incur significant losses and negative cash flows in the near future.

Our Quarterly Revenues And Operating Results Could Be Volatile And Difficult To Forecast, And If Our Quarterly Operating Results Are Below The Expectations Of Analysts, The
Market Price Of Our Common Stock May Decline.

Our
quarterly operating results are likely to vary from quarter to quarter. In the short term, we expect our quarterly revenues to depend significantly on a small number of relatively
large orders for our products and services. As a result, our quarterly operating results may fluctuate if we are unable to complete one or more substantial sales on the schedule we anticipated. In
some cases, we recognize revenues from services on a percentage-of-completion basis. Our ability to recognize these revenues may be delayed if we are unable to meet service
milestones on a timely basis. In the longer term, we expect
to recognize an increasing percentage of revenues based on our receipt of royalty reports. Delays in network operators' deployment schedules or our receipt of royalty reports could adversely affect
our revenues for any given quarter. Because our expenses are relatively fixed in the near term, any shortfall from anticipated revenues could result in greater short-term losses.

We
have found it difficult to forecast the timing and amount of specific sales because our sales process is complex and our sales cycle is long. The purchase of our products and
services involves a significant commitment of capital and other resources by a customer. In many cases, our customers' decision to use our products and services requires them to change their
established business practices and conduct their business in new ways. As a result, we may need to educate our potential customers on the use and benefits of our products and services. In addition,
our customers generally must consider a wide range of other issues before committing to purchase and incorporate our technology into their offerings. As a result of these and other factors, including
the approval at a number of levels of management within a customer's organization, our sales cycle averages from six to twelve months and may sometimes be significantly longer.

We
base our quarterly revenue projections, in part, upon our expectation that specific sales will occur in a particular quarter. In the past, our sales have occurred in quarters other
than those

11

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anticipated by us. If our expectations, and thus our revenue projections, are not accurate for a particular quarter, our actual operating results for that quarter could fall below the expectations of
financial analysts and investors, resulting in a potential decline in our stock price.

Although
we have limited historical financial data, in the past we have experienced seasonal decreases in our rate of revenue growth in our quarter ending August 31. These
seasonal trends may continue to affect our quarter-to-quarter revenues.

We Have Relied And Expect To Continue To Rely On A Limited Number Of Customers For A Significant Portion Of Our Revenues.

We
currently derive, and expect to continue to derive, a significant portion of our revenues from a limited number of customers. For fiscal 1999, our four largest customers accounted
for 52% of our total revenues, with Wind River Systems accounting for 23% of total revenues and NTL accounting for 15% of total revenues. For fiscal 2000, our five largest customers accounted for 54%
of our total revenues, with NTL accounting for 21% of total revenues and Wind River Systems accounting for 15%
of total revenues. For fiscal 2001, our four largest customers accounted for 54% of our total revenues, with NTL accounting for 21% of total revenues and Telewest accounting for 19% of total revenues.
The percentages for NTL include amounts previously reported for Cable and Wireless Communications. In May 2000, NTL acquired the consumer cable and certain other operations of Cable and
Wireless. We expect that we will continue to depend upon a limited number of customers for a significant portion of our revenues in future periods, although the specific customers may vary from period
to period. As a result, if we fail to successfully sell our products and services to one or more customers in any particular period, or a large customer purchases fewer of our products or services,
defers or cancels orders, or terminates its relationship with us, our revenues could decline significantly.

International Revenues Account For A Significant Portion Of Our Revenues; Accordingly, If We Are Unable To Expand Or Hedge Our International Operations In A Timely Manner, Our
Financial Results Will Be Harmed.

International
revenues accounted for 51% of our total revenues for fiscal 1999, 53% of our total revenues for fiscal 2000, and 68% of our total revenues for fiscal 2001. For fiscal
1999, 2000, and 2001, revenues by region are as follows (in thousands):

Years Ended May 31,1999

2000

2001Europe

$
3,212

$
8,296

$
26,604North America


9,129


14,709


19,810Asia


4,972


5,012


5,295Consolidated

$
17,313

$
28,017

$
51,709


Revenues
are assigned to specific countries based on the origin of the sales contract. For fiscal 1999, 2000, and 2001, North America revenues included United-States-based revenues of
$8.5 million, $13.2 million, and $16.6 million, respectively. In addition, for fiscal 1999, 2000, and 2001, Europe revenues included United-Kingdom-based revenues of
$2.5 million, $7.1 million, and $21.2 million, respectively.

We
expect to derive a significant portion of our revenues for the foreseeable future from sources outside the United States, especially as we increase our sales and marketing
activities with respect to international licenses. Accordingly, our success will depend, in part, upon international economic

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conditions and our ability to manage international sales and marketing operations. To successfully expand international sales, we must establish additional foreign operations, hire additional
personnel, and increase our foreign direct and indirect sales forces. This expansion will require significant management attention and resources, which could divert attention from other aspects of our
business. Failing to expand our international operations in a timely manner would limit the growth of our international revenues. See Note 3 of Notes to Consolidated Financial Statements.

Moreover,
substantially all of our revenues and costs to date have been denominated in U.S. dollars. However, expanded international operations are likely to result in increased
foreign currency payables. Although we may from time to time undertake foreign exchange hedging transactions to cover a portion of our foreign currency transaction exposure, we do not currently do so.
Accordingly, any fluctuation in the value of foreign currency could seriously harm our international revenues.

Competition From Bigger, Better Capitalized Competitors Could Result In Price Reductions, Reduced Gross Margins, And Loss Of Market Share.

We
face intense competition in licensing software for networks and consumer devices. Our principal competitors in the client software market include Microsoft, OpenTV,
Canal + Technologies, and PowerTV (a wholly-owned subsidiary of Scientific Atlanta). Our primary competitor in the server market is Microsoft. We expect additional competition from other
established and emerging companies in the television, computing, software, and telecommunications sectors. Increased competition could result in price reductions, fewer customer orders, reduced gross
margins, longer sales cycles, reduced revenues, and loss of market share.

Several
of our existing and potential competitors have one or more of the following advantages: longer operating histories, larger customer bases, greater name recognition, more
patents relating to important technologies, and significantly greater financial, technical, sales and marketing, and other resources. This may place us at a disadvantage in responding to their pricing
strategies, technological advances, advertising campaigns, strategic partnerships, and other initiatives. Our competitors may be able to respond more quickly to new or emerging technologies and
changes in customer requirements, or to devote greater resources to the development, marketing, promotion, and sale of their technologies than we can. In addition, many of our competitors have
well-established relationships with our current and potential customers. Some of our competitors, particularly Microsoft, have made and may continue to make large strategic investments in
our current and potential customers. Such investments may allow our competitors to strengthen existing relationships or quickly establish new relationships with our current or potential customers.

Our Products May Contain Errors Or Be Unable To Support And Manage A Potentially Unlimited Number Of Users.

Software
development is an inherently complex and subjective process, which frequently results in products that contain errors, as well as defective or non-competitive
features or functions. Moreover, our technology is integrated into the products and services of our network operator customers. Accordingly, a defect, error, or performance problem with our technology
could cause our customers' cable and satellite television or other telecommunications systems to fail for a period of time. Any such failure could cause severe customer service and public relations
problems for our customers and could result in delayed or lost revenue due to adverse customer reaction, negative publicity, and damage claims.

Despite
frequent testing of our software's scalability in a laboratory environment and in customer deployments, the ability of our software platform to support and manage a
potentially unlimited number of users is uncertain. If our software platform does not efficiently scale in this way while

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maintaining a high level of performance, demand for our products and services and our ability to sell additional products to our existing customers will be significantly reduced.

Our Success Depends On Our Ability To Keep Pace With The Latest Technological Changes, And Any Delays Or Failure In Developing And Introducing New Software Products Could
Result In A Loss Of Market Share Or Render Our Technology Obsolete.

The
market for consumer device and network operations software is characterized by evolving industry and governmental standards, rapid technological change, and frequent new product
introductions and enhancements. Accordingly, our success will depend in large part upon our ability to adhere to and adapt our products to evolving communications protocols and standards. Therefore,
we will need to develop and introduce new products that meet changing customer requirements and emerging industry and governmental standards on a timely and cost-effective basis. We have
encountered, in the past, and may encounter in the future, delays in completing the development and introduction of new software products. Any delays or failure in developing or introducing new
products that meet consumer requirements, technological requirements, or industry or governmental standards could result in a loss of customers and render our products and services obsolete or
non-competitive.

As We Exhaust Sales Opportunities In Our Existing Markets, We May Be Unable To Identify And Take Advantage Of New Business Opportunities.

Our
unproven, long-term business model depends on generating the majority of our revenues from license and royalty fees paid by network operators and consumer device
manufacturers. If we are unable to identify and take advantage of new business opportunities, we may not be able to maintain our historical rates of revenue growth.

We
hope to increase our potential revenues by expanding our sales efforts to reach customers we have not traditionally targeted. So far, we have primarily targeted sales to large
network operators and manufacturers of set-top boxes. However, worldwide, there are only a limited number of large network operators and, in the United States, only a few manufacturers of
set-top boxes. In the future, we hope to expand our sales efforts to reach a wider variety of customers, including producers, vendors, and aggregators of content; service providers; and
manufacturers of other types of consumer devices, such as game consoles, smart phones, and personal digital assistants. We may not succeed in customizing our software to meet the unique needs of those
devices. We do not have experience making these kinds of sales and may not be successful. We may choose to expand our indirect distribution to reach these new customers, but may be unable to attract
indirect channel partners able to effectively market and sell our products and services. Gaining direct sales experience and expanding our indirect distribution would require significant company
resources and management attention, which could harm our business if our efforts do not generate significant revenues.

We
also hope to increase our potential revenues by creating more extensions to our software platform. However, we may not be successful in developing or selling those extensions, and
may incur significant development costs not offset by new revenues. See also "Risk Factors-Our Success Depends On Our Ability To Keep Pace With The Latest Technological Changes, And Any
Delays Or Failure In Developing And Introducing New Software Products Could Result In A Loss Of Market Share Or Render Our Technology Obsolete."

We May Have To Cease Or Delay Product Shipments If We Are Unable To Obtain Key Technology From Third Parties.

We
rely on technology licensed from third parties, including applications that are integrated with internally developed software and used in our products. Most notably, we license
certain technologies

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from BitStream, Macromedia, RealNetworks, RSA, and Sun Microsystems. These third-party technology licenses may not continue to be available to us on commercially reasonable terms, or at all, and we
may not be able to obtain licenses for other existing or future technologies that we desire to integrate into our products. If we cannot maintain existing third-party technology licenses or enter into
licenses for other existing or future technologies needed for our products, we may be required to cease or delay product shipments while we seek to develop or license alternative technologies.

We May Be Subject To Third-Party Intellectual Property Infringement Claims That Could Be Costly And Time-Consuming To Defend, And We Do Not Have Insurance To
Protect Against These Claims.

We
expect that, like other software product developers, we will increasingly be subject to infringement claims as the number of products and competitors developing consumer device
software grows, software patents become more common, and the functionality of products in different industry segments overlaps. From time to time, we hire or retain employees or external consultants
who have worked for independent software vendors or other companies developing products similar to ours. These prior employers may claim that our products are based on their products and that we have
misappropriated their intellectual property.

Several
other companies involved in the interactive television market have large patent portfolios that they have aggressively sought to enforce. While we do not believe we currently
infringe such patents, and believe that we have valuable patents that we could seek to enforce in event of litigation, claims of infringement are always possible, and success in litigation or other
successful resolution of claims is by no means assured.

We
currently do not have liability insurance to protect against the risk that our own technology or licensed third-party technology infringes the intellectual property of others.
Claims relating to our intellectual property, regardless of their merit, could seriously harm our ability to develop and market our products and manage our day-to-day
operations because they could be time-consuming and costly to defend, divert management's attention and resources, cause product shipment delays, require us to redesign our products, and
require us to enter into royalty or licensing agreements.

Our Limited Ability To Protect Our Intellectual Property And Proprietary Rights May Harm Our Competitiveness.

Our
ability to compete and continue to provide technological innovation depends substantially upon internally developed technology. We rely primarily on a combination of patents,
trademark laws, copyright laws, trade secrets, confidentiality procedures, and contractual provisions to protect our proprietary technology. While we have a number of patent applications pending,
patents may not issue from these or any future applications. In addition, our existing and future patents may not survive a legal challenge to their validity or provide significant protection for us.

The
steps we have taken to protect our proprietary rights may not be adequate to prevent misappropriation of our proprietary information. Further, we may not be able to detect
unauthorized use of, or take appropriate steps to enforce, our intellectual property rights. Our competitors may also independently develop similar technology. In addition, the laws of many countries
do not protect our proprietary rights to as great an extent as do the laws of the United States. Any failure by us to meaningfully protect our intellectual property could result in competitors
offering products that incorporate our most technologically advanced features, which could seriously reduce demand for our products and services.

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Oracle Holds A Substantial Portion Of Our Stock And Could Limit The Ability Of Other Stockholders To Influence The Outcome Of Director Elections And Other Transactions
Submitted For A Vote Of Our Stockholders And Could Cause Our Stock Price To Decline With Large Sales Of Our Stock.

As
of July 31, 2001, Oracle beneficially owned 33,399,843 shares, 32% of our outstanding common stock, based on 105,209,957 shares outstanding. No Oracle designee currently
serves on our Board of Directors. While Oracle has contributed these shares to a voting trust committed to voting them in proportion to all other voted shares, if Oracle were to withdraw the shares
from this trust, it might exert significant influence the election of directors, significant corporate transactions (such as acquisitions), efforts to block an unsolicited tender offer, and other
matters that require stockholder approval. This concentration of ownership could also delay or prevent a third party from acquiring control over us at a premium above the then-current
market price of our common stock.

If
Oracle or other large holders of our stock were to sell large amounts of their holdings, our stock price could decline and we could find it difficult to raise capital through the
sale of additional equity securities. Other owners of large amounts of our stock as of July 31, 2001 were Cisco Systems, with 3,963,780 shares (4% of our outstanding common stock), and AOL Time
Warner, with 2,998,245 shares (3% of our outstanding common stock).

In Order To Remain Competitive In Our Market, We May Need To Make Acquisitions That Could Be Difficult To Integrate, Disrupt Our Business, And Dilute Stockholder Value.

We
may acquire other businesses in the future in order to remain competitive or to acquire new technologies. As a result of future acquisitions, we may need to integrate product
lines, technologies, personnel, customers, widely dispersed operations, and distinct corporate cultures. These integration efforts may not succeed or may distract our management from operating our
existing business. Our failure to successfully manage future acquisitions could seriously harm our operating results. In addition, our stockholders would be diluted if we were to finance acquisitions
by incurring convertible debt or issuing equity securities.

We May Not Be Successful In Making Strategic Investments.

In fiscal 2001, we established the Liberate Corporate Venture Fund to make strategic investments in other companies. In most instances, we make investments in
return for equity securities of private
companies, for which there is no public market. These companies may be expected to incur substantial losses and may never become profitable, publicly traded companies. Even if they do, an active
trading market for their securities may never develop and we may never realize any return on these investments. During fiscal 2001, we wrote down these investments by $5.3 million, as their
fair market value had been permanently impaired. If these companies are not successful, we could incur additional future charges related to write-downs or write-offs of these types of
assets. Losses or charges resulting from these investments could harm our operating results. See also "Business-Liberate Corporate Venture Fund" and Note 2 of Notes to Consolidated Financial
Statements.

Failure To Manage Our Growth May Seriously Harm Our Ability To Deliver Products In A Timely Manner, Fulfill Existing Customer Commitments, And Attract And Retain New Customers.

Our
rapid growth has placed, and is expected to continue to place, a significant strain on our managerial, operational, and financial resources, especially as more network operators
and consumer device manufacturers incorporate our software into their products and services. This potential for rapid growth is particularly significant in light of the large customer bases of network
operators and consumer device manufacturers and the frequent need to tailor our products and services to our customers' unique needs. To the extent we add several customers simultaneously or add
customers

16

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whose product needs require extensive customization, we may need to significantly expand our operations. Moreover, we expect to expand our domestic and international operations significantly by, among
other things, expanding the number of employees in consulting and engineering services, research and development, and sales and marketing.

Our
future success will depend, in part, upon the ability of our senior management to manage growth effectively. This will require us to implement additional management information
systems; to further develop our operating, administrative, financial, and accounting systems and controls; to hire additional personnel; to develop additional levels of management; to locate
additional office space in the United States and abroad; and to maintain close coordination among our research and development, sales and marketing, services and support, and administrative
organizations. Failure to meet any of these requirements would seriously harm our ability to deliver products in a timely fashion, fulfill existing customer commitments, and attract and retain new
customers.

The Loss Of Any Of Our Key Personnel Would Harm Our Competitiveness.

We believe that our success will depend on the continued employment of our senior management team and key technical personnel, particularly Mitchell E.
Kertzman, our Chief Executive Officer; Coleman Sisson, our President and Chief Operating Officer; Donald Fitzpatrick, our Executive Vice President, Sales and Service; and David Limp, our Executive
Vice President and Chief Strategy Officer. If these or other members of our senior management team or key technical personnel are unable or unwilling to continue in their present positions, they could
be difficult to replace, which could harm our ability to manage day-to-day operations, develop and deliver new technologies, attract and retain customers, attract and retain
other employees, and generate revenues.

We May Incur Net Losses Or Increased Net Losses If We Are Required To Record A Significant Accounting Expense Related To The Issuance Of Warrants.

In
fiscal 1999, we entered into letter agreements with several network operators whereby we agreed to issue warrants to purchase up to 4,599,992 shares of our common stock that can be
earned and exercised if those network operators satisfy certain milestones within specific time frames. The value of the warrants is estimated using the Black-Scholes pricing model as of the earlier
of the grant date or the date that it becomes probable that the warrants will be earned. Pursuant to the requirements of Emerging Issues Task Force No. 96-18, the warrants will
continue to be revalued in situations where they are granted prior to the establishment of a performance commitment. The value of the warrants is recorded primarily as a non-current asset
on the accompanying consolidated balance sheets and is being amortized over the estimated economic life of the arrangements with the network operators.

As
of May 31, 2001, these network operators had earned warrants to purchase up to 2,336,660 shares of our common stock. The value of these warrants at the time they were
earned, based on the Black-Scholes pricing model, was $117.2 million. As of May 31, 2001, accumulated amortization for the warrants was $34.0 million.

If
the remaining warrants are earned, we may be required to record additional significant non-cash accounting expenses. As a result, we could incur net losses or increased
net losses for a given period and this could seriously harm our operating results and result in a decline of our stock price.

New Or Changed Government Regulation Could Significantly Reduce Demand For Our Products And Services.

We
are subject not only to regulations applicable to businesses generally, but also laws and regulations directly applicable to the Internet, cable and satellite television networks,
and other

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telecommunications content and services. Although there are currently few such laws and regulations, state, federal, and foreign governments may adopt laws and regulations that adversely affect us or
our markets in any of the following areas: user privacy, copyrights, consumer protection, taxation of e-commerce, the online distribution of content, and the characteristics and quality of
online products and services. In particular, government laws or regulations restricting or burdening the exchange of personally identifiable information could delay the implementation of interactive
services or create liability for us or other manufacturers of software that facilitates information exchange. Also, if we have to re-design our products to comply with new or changed
government laws or regulations, we could face additional expense and delay in delivering our products to our customers. See "Risk Factors-Our Success Depends On Our Ability To Keep Pace With The
Latest Technological Changes, And Any Delays Or Failure In Developing And Introducing New Software Could Result In A Loss Of Market Share Or Render Our Technology Obsolete."

Moreover,
the market for television, and particularly cable and satellite television, is extensively regulated by a large number of national, state, and local government agencies. New
or altered laws or regulations regarding interactive television that change its competitive landscape, limit its market, or affect its pricing could seriously harm our business prospects.

We Expect Our Operations To Continue To Produce Negative Cash Flow In The Near Term; Consequently, If We Should Need Additional Capital And Cannot Raise It, We May Not Be Able
To Fund Our Continued Operations.

Since
our inception, cash used in our operations has substantially exceeded cash received from our operations and we expect this trend to continue for the near future. We believe that
our existing cash balances will be more than sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. At some point in the future, we may need to
raise additional funds and we cannot be certain that we will be able to obtain additional financing on favorable terms, or at all. If we
need additional capital and cannot raise it on acceptable terms, we may not be able to develop our products and services, acquire complementary technologies or businesses, open new offices, hire and
retain employees, or respond to competitive pressures or new business requirements.

Provisions Of Our Corporate Documents And Delaware Law Could Deter Takeovers And Prevent Stockholders From Receiving A Premium For Their Shares.

Certain
provisions of our certificate of incorporation and bylaws may discourage, delay, or prevent a change in control of our company that a stockholder may consider favorable. These
include provisions that:



18

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In
addition, Section 203 of the Delaware General Corporation Law and provisions in our stock incentive plans may discourage, delay, or prevent a change in control of our
company.

We Have Been Named In Securities Class-Action Litigation And May Be Named In Additional Litigation.

Beginning
May 16, 2001, seven class-action lawsuits seeking monetary damages were filed in the Southern District of New York against several of the firms that underwrote our
initial public offering, naming Liberate, our CEO Mitchell Kertzman, and our CFO Nancy Hilker as co-defendants ("the Liberate defendants"). The plaintiffs allege that the underwriters
received excessive and improper commissions that were not disclosed in our prospectus. We believe that these cases are likely to be consolidated. A large number of companies have been named in similar
suits relating to allegedly improper underwriting practices. We will be seeking to have the claims against the Liberate defendants dismissed, and, while litigation is by its nature uncertain, we do
not believe that the cases create any material exposure for Liberate.

More
generally, securities class-action litigation has often been brought against a company following periods of volatility in the market price of its securities. This risk is
especially acute for us because technology companies have experienced greater-than-average stock price volatility in recent years and, as a result, have been subject to, on
average, a greater number of securities class action claims than companies in other industries. Due to the volatility of our stock price, we may in the future be the target of this kind of litigation.
Securities litigation could result in substantial costs and divert management's attention and resources.

ITEM 2. PROPERTIES

We lease approximately 181,000 square feet of office space for our headquarters and development offices in San Carlos, California. We lease approximately
20,000 square feet in London, Ontario, Canada; approximately 16,000 square feet in Horsham, Pennsylvania; and approximately 10,000 square feet in Murray City, Utah for development offices. We also
lease approximately 4,700 square feet in London, England, and an office suite in Tokyo, Japan for sales offices.

Approximately
78,000 square feet of our headquarters office space is available for sublease to third parties. For fiscal 2000 and 2001 we recorded rental income from subleases of
$1.1 million and $4.9 million, respectively, which is netted against rent expense and credited to other income as appropriate. We have engaged a commercial real estate broker to market
this space. However, demand in the San Francisco Bay Area commercial real estate market is extremely low at this time and the space may remain vacant for an extended period of time.

ITEM 3. LEGAL PROCEEDINGS

Beginning May 16, 2001, seven class-action lawsuits seeking monetary damages were filed in the Southern District of New York against several of the
firms that underwrote our IPO, naming Liberate, our CEO Mitchell Kertzman, and our CFO Nancy Hilker as co-defendants ("the Liberate defendants"). The plaintiffs allege that the
underwriters received excessive and improper commissions that were not disclosed in our prospectus. We believe that these cases are likely to be consolidated. A large number of companies have been
named in similar suits relating to allegedly improper underwriting practices. We will be seeking to have the claims against the Liberate defendants dismissed, and, while litigation is by its nature
uncertain, we do not believe that the cases create any material exposure for Liberate.

As
part of our acquisition of the VirtualModem software products and related assets and technology of SourceSuite described in Note 4 of Notes Consolidated Financial
Statements, we acquired certain patents that were the subject of a patent infringement lawsuit. This lawsuit was initially

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brought by Interactive Channel Technologies and SMI Holdings, affiliated companies of SourceSuite, against Worldgate Communications in May 1998 in the U.S. District Court for the State of
Delaware. The patent infringement claims have been assigned to us as a result of our merger with SourceSuite. In June 1998, Worldgate filed a counterclaim against the plaintiffs and Source
Media, a shareholder of SourceSuite, alleging among others, violations of the Lanham Act and Delaware's Uniform Deceptive Trade Practices Act, common law unfair competition, tortious interference with
existing and prospective business relationships and misappropriation of confidential information and trade secrets. Following discovery and briefing of the patent claim construction issues, the
parties have entered into settlement negotiations covering both our patent infringement claims against Worldgate and Worldgate's cross-complaint against Interactive Channel, SMI Holdings, and Source
Media. On March 26, 2001, the U.S. District Court for the State of Delaware ruled that the parties have entered into a settlement agreement under which each side dismissed its claims against
the other.

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

None.

ITEM 4a. EXECUTIVE OFFICERS

The executive officers of Liberate, and their ages as of July 31, 2001, are as follows:

Name

Age

PositionMitchell E. Kertzman

52

Chief Executive Officer and DirectorColeman Sisson

44

President and Chief Operating OfficerDonald M. Fitzpatrick

44

Executive Vice President, Sales and ServiceDavid A. Limp

35

Executive Vice President and Chief Strategy OfficerNancy J. Hilker

43

Senior Vice President and Chief Financial OfficerKent Walker

40

Senior Vice President, General Counsel, and Secretary


Mitchell E. Kertzmanhas served as Chief Executive Officer and a member of Liberate's Board of Directors since joining Liberate in
November 1998. Prior to joining Liberate, Mr. Kertzman was a member of the board of directors of Sybase, a database company, from February 1995 until he joined Liberate. He served
as Chairman of Sybase's board of directors since July 1997. Between February 1998 and August 1998, he also served as Co-Chief Executive Officer of Sybase. From
July 1996 until February 1997, Mr. Kertzman served as Chief Executive Officer of Sybase, and from July 1996 until July 1997 he also served as President of Sybase.
Between February 1995 and July 1996, he served as an Executive Vice President of Sybase. In February 1995, Sybase merged with Powersoft Corporation, a provider of application
development tools. Mr. Kertzman had served as Chief Executive Officer and a director of Powersoft since he founded it in 1974. He also served as President of Powersoft from April 1974 to
June 1992. Mr. Kertzman also serves as a director of CNET Networks and Handspring.

Coleman Sissonjoined Liberate in November 1999, and currently serves as President and Chief Operating Officer. Prior to joining
Liberate, Mr. Sisson was President and Chief Operating Officer of CyberSafe, a network security company, from July 1997 to November 1999. From August 1995 to
July 1997, Mr. Sisson served as Senior Vice President and General Manager, Education Services Group, at Vanstar, a technology product and services company. From June 1992 to
August 1995, Mr. Sisson served as Vice President, Worldwide Customer Services, at Powersoft.

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Donald M. Fitzpatrickjoined Liberate in November 1999, and currently serves as Executive Vice President, Sales and Service.
Prior to joining Liberate, Mr. Fitzpatrick headed the Interactive Services business for Oracle Corporation in Europe, the Middle East, and Africa, beginning in April 1996. From
November 1992 to March 1996, Mr. Fitzpatrick was Software Development Manager for the software services business unit of Ferntree Computer Corporation of Australia.

David A. Limpjoined Navio in December 1996, and currently serves as Liberate's Executive Vice President and Chief Strategy
Officer. Prior to joining Navio, Mr. Limp served in various capacities at Apple Computer from July 1987 to November 1996, most recently as director of its North and South American
PowerBook division.

Nancy J. Hilkerjoined Navio in July 1996, and currently serves as Liberate's Senior Vice President and Chief Financial Officer.
From June 1991 to July 1996, Ms. Hilker served in various capacities at IntelliCorp, a software company, most recently as Chief Financial Officer and Secretary. From
October 1979 to June 1991, Ms. Hilker held various positions at Deloitte & Touche, an accounting firm, as a manufacturing and high technology specialist in the emerging
business services group. Ms. Hilker is a Certified Public Accountant.

Kent Walkerjoined Liberate in October 2000 and currently serves as Senior Vice President, General Counsel, and Secretary. Prior
to joining Liberate, Mr. Walker served as Associate General Counsel of America Online / Netscape, from April 1997 to October 2000, as Senior Counsel to AirTouch Communications,
from March 1995 to April 1997, and as an Assistant U.S. Attorney with the U.S. Department of Justice from 1990 to 1995.

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PART II

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

Price Range of Common Stock

Our common stock has been traded on the Nasdaq National Market under the symbol "LBRT" since July 28, 1999. The following table sets forth, for the
periods indicated, the high and low closing sale prices per share of our common stock as reported on the Nasdaq National Market:

|Fiscal 2000                             |  | High |        | Low
|--------------------------------------- |  | ---- | ------ | ---
|First Quarter (beginning July 28, 1999) |  | $    | 13.50  |    
|Second Quarter                          |  | $    | 84.19  |    
|Third Quarter                           |  | $    | 128.53 |    
|Fourth Quarter                          |  | $    | 114.50 |    

|Fiscal 2001    |  | High |       | Low
|-------------- |  | ---- | ----- | ---
|First Quarter  |  | $    | 34.13 |    
|Second Quarter |  | $    | 32.94 |    
|Third Quarter  |  | $    | 20.56 |    
|Fourth Quarter |  | $    | 10.80 |    

As
of July 31, 2001, the last reported sales price of our common stock was $12.05 per share, and there were 510 holders of record of our common stock. This does not include the
number of persons whose stock is held in "street name" accounts through brokers.

Recent Sales of Unregistered Securities

During our fiscal year ended May 31, 2001, we have issued and sold the following unregistered securities:

Dividend Policy

We have not paid any cash dividends since our incorporation and do not intend to pay any cash dividends in the foreseeable future.

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Use of Proceeds

On July 27, 1999, the Securities and Exchange Commission declared effective our Registration Statement on Form S-1 (File
No. 333-78781) for our initial public offering, or IPO. In the IPO, we sold an aggregate of 13,402,100 shares of our common stock (including 902,100 shares in connection with the
exercise of the underwriters' overallotment), at $8.00 per share (all share numbers and the share price are split-adjusted). The IPO generated gross proceeds of $107.2 million for us. Our net
proceeds were $97.8 million, after deducting $9.4 million in underwriters' discounts and other related costs of the IPO.

On
February 17, 2000 (following our stock split), we commenced a secondary stock offering, or Secondary Offering, pursuant to a Registration Statement on
Form S-1 (File No. 333-95139). In the Secondary Offering, we sold 2,890,000 shares of our common stock at $108 per share, for gross proceeds of
$312.1 million. Net proceeds from this transaction, after underwriters' discounts and other related costs of $14.9 million, were $297.2 million.

For
the IPO, both Credit Suisse First Boston and Hambrecht & Quist served as managing underwriters. For the Secondary Offering, Credit Suisse First Boston served as the
managing underwriter. For both offerings, we directly paid the underwriters (none of whom was affiliated with us, our directors, or our officers) for their underwriting expenses.

Our
IPO concluded on August 2, 1999 and our Secondary Offering concluded on February 24, 2000. In each case, all securities registered were sold.

We
intend to continue to use the net proceeds of our IPO and Secondary Offering for general corporate purposes, such as funding our operating losses, working capital needs,
expenditures for
research and development, and sales and marketing efforts. In addition, we may use a portion of the net proceeds to fund acquisitions or investments in complementary businesses, technologies, or
products. Pending any of these uses, we will continue to hold the net proceeds in cash, cash equivalents, or short-term investments.

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ITEM 6. SELECTED FINANCIAL DATA

Please read the following selected consolidated financial data (in thousands, except per share data) in conjunction with the "Management's Discussion and
Analysis of Financial Condition and Results of Operations," Consolidated Financial Statements, and Notes thereto, and with other financial data included elsewhere in this Form 10-K.
The consolidated statements of operations data for the years ended May 31, 1999, 2000, and 2001, and the consolidated balance sheet data as of May 31, 2000 and 2001, are derived from
audited consolidated financial statements included elsewhere in this Form 10-K. The consolidated statements of operations for the years ended May 31, 1997 and 1998, and the
consolidated balance sheet data as of May 31, 1997, 1998, and 1999, are derived from audited consolidated financial statements not included in this Form 10-K. These
historical results do not necessarily indicate the results to be expected in any future period.

|                                            |                                              |                                            |         | Years Ended May 31, |         |          |       
|------------------------------------------- | -------------------------------------------- | ------------------------------------------ | ------- | ------------------- | ------- | -------- | ------
|
|Consolidated Statements of Operations:      |                                              |                                            |         |                     |         |          |       
|REVENUES:                                   |                                              |                                            |         |                     |         |          |       
|                                            | License and royalty                          |                                            | $       | 231                 |         | $        | 4,162 
|                                            | Service                                      |                                            |         | 44                  |         |          | 6,110 
|                                            |                                              |                                            |         |                     |         |          |       
|                                            |                                              | Total revenues                             |         |                     | 275     |          |       
|                                            |                                              |                                            |         |                     |         |          |       
|COST OF REVENUES:                           |                                              |                                            |         |                     |         |          |       
|                                            | License and royalty                          |                                            |         |                    |         |          | 3,779 
|                                            | Service                                      |                                            |         |                    |         |          | 2,230 
|                                            |                                              |                                            |         |                     |         |          |       
|                                            |                                              | Total cost of revenues                     |         |                     |        |          |       
|                                            |                                              |                                            |         |                     |         |          |       
|                                            |                                              | Gross margin                               |         |                     | 275     |          |       
|                                            |                                              |                                            |         |                     |         |          |       
|OPERATING EXPENSES:                         |                                              |                                            |         |                     |         |          |       
|                                            | Research and development                     |                                            |         | 21,721              |         |          | 19,981
|                                            | Sales and marketing                          |                                            |         | 7,805               |         |          | 14,407
|                                            | General and administrative                   |                                            |         | 1,023               |         |          | 2,453 
|                                            | Amortization of purchased intangibles        |                                            |         |                    |         |          | 4,563 
|                                            | Amortization of warrants                     |                                            |         |                    |         |          |      
|                                            | Amortization of deferred stock compensation  |                                            |         |                    |         |          |      
|                                            | Acquired in-process research and development |                                            |         |                    |         |          | 58,100
|                                            | Restructuring charges                        |                                            |         |                    |         |          | 1,175 
|                                            |                                              |                                            |         |                     |         |          |       
|                                            |                                              | Total operating expenses                   |         |                     | 30,549  |          |       
|                                            |                                              |                                            |         |                     |         |          |       
|                                            |                                              | Loss from operations                       |         |                     | (30,274 | )        |       
|INTEREST INCOME (EXPENSE)                   |                                              |                                            | (336    | )                   |         | 115      |       
|OTHER INCOME (EXPENSE), net                 |                                              |                                            | (129    | )                   |         | (105     | )     
|                                            |                                              |                                            |         |                     |         |          |       
|                                            |                                              | Loss before income tax provision (benefit) |         |                     | (30,739 | )        |       
|INCOME TAX PROVISION (BENEFIT)              |                                              |                                            | (11,750 | )                   |         | (2,015   | )     
|                                            |                                              |                                            |         |                     |         |          |       
|                                            |                                              | Net loss                                   |         | $                   | (18,989 | )        | $     
|                                            |                                              |                                            |         |                     |         |          |       
|BASIC LOSS PER SHARE                        |                                              | $                                          |        |                     | $       | (890.48  | )     
|SHARES USED IN COMPUTING NET LOSS PER SHARE |                                              |                                            |        |                     |         | 106      |       
|Consolidated Balance Sheet Data:            |                                              |                                            |         |                     |         |          |       
|Cash and cash equivalents                   |                                              | $                                          | 245     |                     | $       | 12,138   |       
|Working capital (deficit)                   |                                              |                                            | (23,180 | )                   |         | (18,275  | )     
|Total assets                                |                                              |                                            | 4,441   |                     |         | 32,311   |       
|Deferred revenues                           |                                              |                                            | 45      |                     |         | 25,367   |       
|Total long-term liabilities                 |                                              |                                            |        |                     |         | 4,115    |       
|Accumulated deficit                         |                                              |                                            | (22,268 | )                   |         | (116,659 | )     
|Total stockholders' equity (deficit)        |                                              |                                            | (19,256 | )                   |         | (6,136   | )     

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The following table represents the respective balances as a percentage of total revenues:

|                                            |                                              | Years Ended May 31,                        |      
|------------------------------------------- | -------------------------------------------- | ------------------------------------------ | -----
|
|Consolidated Statements of Operations Data: |                                              |                                            |      
|REVENUES:                                   |                                              |                                            |      
|                                            | License and royalty                          |                                            | 84   
|                                            | Service                                      |                                            | 16   
|                                            |                                              |                                            |      
|                                            |                                              | Total revenues                             |      
|                                            |                                              |                                            |      
|COST OF REVENUES:                           |                                              |                                            |      
|                                            | License and royalty                          |                                            |     
|                                            | Service                                      |                                            |     
|                                            |                                              |                                            |      
|                                            |                                              | Total cost of revenues                     |      
|                                            |                                              |                                            |      
|                                            |                                              | Gross margin                               |      
|                                            |                                              |                                            |      
|OPERATING EXPENSES:                         |                                              |                                            |      
|                                            | Research and development                     |                                            | 7,899
|                                            | Sales and marketing                          |                                            | 2,838
|                                            | General and administrative                   |                                            | 372  
|                                            | Amortization of purchased intangibles        |                                            |     
|                                            | Amortization of warrants                     |                                            |     
|                                            | Amortization of deferred stock compensation  |                                            |     
|                                            | Acquired in-process research and development |                                            |     
|                                            | Restructuring charges                        |                                            |     
|                                            |                                              |                                            |      
|                                            |                                              | Total operating expenses                   |      
|                                            |                                              |                                            |      
|                                            |                                              | Loss from operations                       |      
|INTEREST INCOME (EXPENSE)                   |                                              | (122                                       | )    
|OTHER INCOME (EXPENSE), net                 |                                              | (47                                        | )    
|                                            |                                              |                                            |      
|                                            |                                              | Loss before income tax provision (benefit) |      
|INCOME TAX PROVISION (BENEFIT)              |                                              | (4,273                                     | )    
|                                            |                                              |                                            |      
|                                            |                                              | Net loss                                   |      
|                                            |                                              |                                            |      

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

OVERVIEW

We are the premier provider of standards-based software platforms for delivering enhanced content and services to television viewers around the world. We began
our operations in late 1995 as a division of Oracle, developing client and server software for the consumer, enterprise, and educational markets. In April 1996, Oracle spun-off our
division as Network Computer, Inc. ("NCI"). NCI's initial focus was on selling software to original equipment manufacturers of network computer products for enterprise customers. In
August 1997, NCI merged with a Netscape Communications subsidiary, Navio, which was developing Internet application and server software for the consumer market. NCI was the surviving entity in
the merger. After the merger, we changed our strategic direction and restructured our operations to focus our development and marketing efforts on products targeted primarily at the consumer device
market, targeting sales to a limited number of large network operators and consumer device manufacturers. On May 11, 1999, we changed our name from NCI to Liberate Technologies.

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Since our incorporation, we have raised a significant amount of capital by selling small equity positions to a number of investors, including some major network operators. This has
provided us with the financial resources we needed to continue our growth, given us resources to pursue investments and acquisitions as appropriate, and also reinforced our relationships with
participating network operators. In order to continue to fund our growth, we decided to offer our stock to the public and become a publicly traded company. We commenced our IPO on July 28,
1999. We raised additional capital in February 2000 through a secondary public offering and again in July 2000 when Cisco Systems invested $100.0 million through a private
placement.

In
fiscal 1999, we entered into letter agreements with several network operators whereby we agreed to issue warrants to purchase up to 4,599,992 shares of our common stock that can be
earned and exercised if those network operators satisfy certain milestones within specific time frames. As of May 31, 2001, these network operators had earned warrants to purchase up to
2,336,660 shares of our common stock. The value of these warrants at the time they were earned, based on the Black-Scholes pricing model, was $117.2 million. As of May 31, 2001, accumulated
amortization for the warrants was $34.0 million. If the remaining warrants are earned, we may be required to record additional significant non-cash accounting expenses. As a result,
we could incur net losses or increased net losses for a given period and this could seriously harm our operating results and result in a decline of our stock price. See Note 8 of Notes to
Consolidated Financial Statements.

In
March 2000, we acquired the VirtualModem assets of SourceSuite in exchange for 1,772,000 shares of our common stock. The acquisition was accounted for as a purchase. The
fair market value of the equity securities issued in the acquisition was $190.5 million. See "Liquidity and Capital Resources" and Note 4 of Notes to Consolidated Financial Statements.

In
June 2000, we acquired MoreCom. In connection with the acquisition, we issued 7,310,830 shares of common stock in exchange for all of the outstanding stock of MoreCom and
assumed all of MoreCom's stock options. The acquisition was accounted for as a purchase. The fair market value of the equity securities issued in the acquisition was $459.0 million. See
"Liquidity and Capital Resources" and Note 4 of Notes to Consolidated Financial Statements.

We
launched the Liberate Corporate Venture Fund in November 2000 to promote the development of interactive television and spur the growth of innovative companies. As of
May 31, 2001, we had invested $15.2 million in our portfolio of companies. In fiscal 2001, we wrote down $5.3 million of equity investments that had been permanently impaired,
reducing our net equity investments to $9.9 million as of May 31, 2001. See Note 2 of Notes to Consolidated Financial Statements.

Since
our incorporation, we have incurred net losses of $536.9 million. These losses include $148.9 million in research and development expenditures,
$248.9 million in amortization of purchased intangibles, $34.0 million in amortization of warrants, $4.4 million in amortization of deferred stock compensation, and
$82.5 million in write-offs of acquired in-process research and development related to our acquisitions. We anticipate incurring significant operating losses for the
foreseeable future as we: (1) continue to invest in research and development and consulting and non-recurring engineering services to support our software platform and large-scale
deployments by our network operator customers, and
(2) record non-cash expenses related to the acquired in-process research and development and amortization of purchased intangibles associated with our acquisitions,
amortization of deferred compensation, and amortization of warrant expense associated with the issuance of warrants.

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YEAR ENDED MAY 31, 2000 AND YEAR ENDED MAY 31, 2001

Revenues

We currently generate revenues by licensing our client and server products, applications, and tools and by providing related services, to network operators,
primarily providers of television services, and consumer device manufacturers, primarily set-top box manufacturers. In addition, we generate revenues from consulting, maintenance, and
other services provided in connection with client and server licenses. Total revenues increased 85% from $28.0 million for fiscal 2000 to $51.7 million for fiscal 2001.

International
revenues accounted for 51% of our total revenues for fiscal 1999, 53% of our total revenues for fiscal 2000, and 68% of our total revenues for fiscal 2001. We anticipate
international revenues will to continue to represent a significant portion of total revenues for the foreseeable future.

Deferred
revenues consist primarily of payments received from customers for prepaid license and royalty fees and prepaid services for undelivered products and services. Deferred
revenues decreased from $69.1 million as of May 31, 2000 to $54.2 million as of May 31, 2001. The majority of this decrease represents recognition of revenues related to
both customer deployments and performance of services. We expect this downward trend to continue in future quarters as our customers continue to deploy. Deferred revenues may fluctuate in future
periods as a result of several factors, including the timing of deployments, performance of services, and prepayments.

License and Royalty.License and royalty revenues consist principally of fees earned from the licensing of our
software, as well as royalty fees earned upon the shipment or activation of products that incorporate our software. We typically recognize revenues from software license fees when the licensed product
is delivered, collection is probable, the fee for each element of the transaction is fixed and determinable, persuasive evidence of an arrangement exists, and vendor-specific objective evidence exists
to allocate the total fee to all delivered and undelivered elements of the arrangement. In addition to license fees, network operators typically pay server royalty fees on a per subscriber basis. We
typically recognize revenue on these server royalty fees when a network operator reports to us that a
user of a consumer device has activated the operator's service. We also license our client software to either network operators or consumer device manufacturers, who typically pay us royalties on a
per unit basis. We typically recognize revenue when our customers report to us that a consumer device owner has activated the operator's service, or a consumer device manufacturer has shipped a
device.

License
and royalty revenues increased 171% from $10.2 million for fiscal 2000 to $27.8 million for fiscal 2001. These amounts represented 37% and 54% of total revenues
for the respective periods. The increase was primarily due to increased deployments to our customers' subscribers. We expect to see more growth in license and royalty revenues as additional network
operators begin to deploy our products.

Service.Service revenues consist of consulting, maintenance, and other services. We generally recognize consulting and
other service revenues, including non-recurring engineering and training revenues, as services are performed. Where consulting services are performed under a fixed-price arrangement,
revenues are generally recognized on a percentage-of-completion basis. Maintenance services include both updates and technical support. Maintenance revenues are recognized
ratably over the term of the maintenance agreement, and generally range between 15% and 25% of the cumulative license fees and activation royalties incurred under the contract, depending upon the
level of support being provided. Where software license agreements include a combination of consulting, maintenance, and other services, these separate elements are unbundled from the arrangement
based on each element's relative fair value.

Service
revenues increased 35% from $17.8 million for fiscal 2000 to $23.9 million for fiscal 2001. These amounts represented 63% and 46% of total revenues for the
respective periods. This increase was primarily due to the continued growth in our customer base, which resulted in an increase in

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integration and implementation services provided to those customers. We expect service revenues to continue to account for a significant portion of total revenues until customers begin deploying
consumer devices incorporating our software on a larger scale. We also expect service revenues to increase to the extent existing and new customers continue to install and initiate deployment of our
products.

Cost of Revenues

Total cost of revenues increased 31% from $23.7 million for fiscal 2000 to $31.2 million for fiscal 2001. We anticipate that total cost of
revenues will increase in future periods as a result of increased deployments and as we introduce new third-party technologies as well as increase levels of service and support for our new and
existing customers' installations and implementations.

License and Royalty.Cost of license and royalty revenues consists primarily of costs incurred for licenses and support
of third-party technologies that are incorporated in our products. Cost of license and royalty revenues decreased 8% from $2.0 million for fiscal 2000 to $1.8 million for fiscal 2001.
These amounts represented 20% and 7% of license and royalty revenues for the respective periods. The decrease in cost of license and royalty revenues as a percent of related revenues was due to lower
amortization expense resulting from the full amortization of certain in-bound licenses, in addition to the renegotiation of a third-party software license and a one-time credit
realized through the cancellation of a third-party technology contract. We expect the cost of license and royalty revenues as a percentage of related revenues may increase in future periods as our
customers deploy in greater volume and as we introduce new third-party technologies.

Service.Cost of service revenues consists primarily of salary and other related costs for personnel and external
contractors. Cost of service revenues increased 35% from $21.7 million for fiscal 2000 to $29.3 million for fiscal 2001. These amounts represented 122% and 123% of service revenues for
the respective periods. The increased costs reflected the increased number of both permanent employees and external contractors required to meet the growth in our customers' service needs. We expect
cost of service revenues to increase in dollar amounts but decrease as a percentage of service revenues in future periods as we initiate new deployments and support installations of our products.

Operating Expenses

Research and Development.Research and development expenses consist primarily of salary and other related costs for
personnel and external contractors, as well as costs related to outsourced development projects necessary to support product development. Research and development expenses increased 59% from
$32.3 million for fiscal 2000 to $51.2 million for fiscal 2001. These amounts represented 115% and 99% of total revenues for the respective periods. The increase in absolute dollar
amounts was primarily due to increases in staffing and employee-related costs. Much of this increase was a result of increased headcount due to the SourceSuite and MoreCom acquisitions. We believe
that continued investment in research and development is critical to attaining our strategic objectives. Consequently, we expect research and development expenses to increase modestly in future
periods. However, if revenues increase, we expect research and development expenses to decline as a percentage of total revenues in the long term.

Sales and Marketing.Sales and marketing expenses consist primarily of salaries and other employee-related costs for
sales and marketing personnel, sales commissions, travel, public relations, marketing materials, tradeshows, and facilities for regional offices. Sales and marketing expenses increased 29% from
$18.7 million for fiscal 2000 to $24.2 million for fiscal 2001. These amounts represented 67% and 47% of total revenues for the respective periods. The increase in absolute dollar
amounts was due to increased staffing and employee-related costs, as well as increased spending for trade shows, public relations, marketing research, and international expansion. We believe sales and

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marketing expenses will increase in future periods as we expand our direct sales and marketing efforts both domestically and internationally. However, if revenues increase, we expect sales and
marketing expenses to decrease as a percentage of total revenues in the long term.

General and Administrative.General and administrative expenses consist primarily of salaries and other employee
related costs for corporate development, finance, human resources, and legal employees, as well as outside legal and other professional fees. General and administrative expenses increased 46% from
$7.8 million for fiscal 2000 to $11.4 million for fiscal 2001. These amounts represented 28% and 22% of total revenues for the respective periods. The increase in absolute dollar amounts
was primarily due to increased employee-related expenses, the establishment of the infrastructure necessary to support our expansion, and higher outside professional service costs. We believe these
expenses will increase modestly as we continue to add personnel and expand our infrastructure. However, if revenues increase, we expect these costs to decrease as a percentage of total revenues in the
long term.

Amortization of Purchased Intangibles.Purchased intangibles represent the purchase price of companies that we have
acquired in excess of identified tangible assets and are amortized over three years. Since our inception, we have recorded purchase intangibles related to three acquisitions:



We
recognized $22.1 million of amortization expense for fiscal 2000 and $216.1 million of amortization expense for fiscal 2001. We expect expenses related to the
amortization of purchased intangibles to remain relatively flat in the near term, however, upon adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
Intangibles," we will cease to record approximately $217.7 million of goodwill amortization expense annually.

Amortization of Warrants.As of May 31, 2001, certain network operators had earned warrants to purchase up to
2,336,660 shares of our common stock. The value of these warrants at the time they were earned, based on the Black-Scholes pricing model, was $117.2 million. We recorded warrant amortization
expense of $10.8 million in fiscal 2000 and $23.2 million in fiscal 2001. We expect warrant amortization expense to increase from present levels only as additional warrants are 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. In fiscal 1999, we began recording deferred stock compensation for
stock options granted to employees and others. These amounts are amortized on a straight-line basis over the 48-month vesting period of such options. Amortization of deferred
stock compensation was $2.1 million for fiscal 2000 compared to $1.9 million for fiscal 2001. This decrease in amortization of deferred stock compensation was attributable to employee
terminations. We anticipate that deferred stock compensation expense will decrease modestly over the next two years, based on the effect of employee terminations and the completion of the vesting of
related stock option grants.

Acquired In-Process Research and Development.Acquired in-process research and development
expense consists of the value of research projects and products that were in process on the date of certain acquisitions that, in the opinion of management, had not reached technological feasibility
and had no alternative future use. Acquired in-process research and development expense was $1.9 million

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for fiscal 2000 compared to $22.4 million for fiscal 2001. The acquired in-process research and development expense for fiscal 2000 was related to our the acquisition of
VirtualModem assets of SourceSuite. Acquired in-process research and development expense for fiscal 2001 related to our acquisition of MoreCom. See Note 4 of Notes to Consolidated
Financial Statements.

Interest Income

Interest income consists of interest earned on our cash and cash equivalents and short-term and long-term investments, and is netted
against interest expense related to capital leases. Interest income increased from $11.6 million for fiscal 2000 to $30.2 million for fiscal 2001. This increase was primarily due to
interest income on proceeds from our IPO of common stock in July 1999, our secondary offering in February 2000, and purchase of our common stock by Cisco Systems in July 2000. See
Note 8 of Notes to Consolidated Financial Statements.

Other Income (Expense), Net

Other income (expense), net consists of write-downs of equity investments that have been permanently impaired, foreign currency exchange gains and losses,
losses on disposals of fixed assets, bank charges, and other non-operating income and expenses. Net other expense increased from $847,000 for fiscal 2000 to $6.2 million for fiscal
2001. The increase in expense for the period was primarily due to a $5.3 million write-down of certain equity investments. This write-down related to
non-public equity security investments whose value was permanently impaired. On a quarterly basis, we evaluated whether the
conditions of the companies affected the recorded amounts of the investments held by us. As a result of this review, we determined that the recorded value for certain of these investments exceeded
their fair market value as of May 31, 2001.

Income Tax Provision

Income tax provision consists of foreign withholding tax expense and foreign and state income taxes. Income tax provision increased from $137,000 for fiscal
2000 to $515,000 for fiscal 2001. The increase was primarily due to increased foreign revenues and operating activities, resulting in increased foreign withholding and income taxes. See Note 10
of Notes to Consolidated Financial Statements.

As
of May 31, 2001, we had federal and state net operating loss carryforwards of $247.8 million and $67.1 million, respectively, and tax credits totaling
$10.6 million. The federal and state net operating loss carryforwards expire at various dates between 2005 and 2021. The tax credits expire at various dates between 2011 and 2021. The Tax
Reform Act of 1986 imposes substantial restrictions on the use of net operating losses and tax credits in the event of an ownership change of a corporation. Our ability to use net operating loss
carryforwards on an annual basis will be limited as a result of a prior ownership change in connection with private sales of equity securities. We have provided a full valuation allowance on the
deferred tax asset because of the uncertainty regarding its realization. Our accounting for deferred taxes under SFAS No. 109, "Accounting for Income Taxes," involves the evaluation of a number
of factors concerning the realizability of our deferred tax assets. In concluding that a full valuation allowance was required, we considered factors such as our history of operating losses, and
expected future losses, and the nature of our deferred tax assets.

YEAR ENDED MAY 31, 1999 AND YEAR ENDED MAY 31, 2000

Revenues



License and Royalty.License and royalty revenues increased 94% from $5.3 million for fiscal 1999 to
$10.2 million for fiscal 2000. This increase was primarily due to increased royalty revenues resulting
from increased deployments, primarily from existing customers, and the expiration of prepayments associated with previous product lines.

Service.Service revenues increased 48% from $12.0 million for fiscal 1999 to $17.8 million for fiscal
2000. This increase was primarily due to the continued expansion of our professional services organization, created in the beginning of fiscal 1999. To a lesser extent, the increase was due to the
overall increase in maintenance revenues.

30

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Cost of Revenues

Total cost of revenues increased 126% from $10.5 million for fiscal 1999 to $23.7 million for fiscal 2000.

License and Royalty.Cost of license and royalty revenues decreased 12% from $2.3 million for fiscal 1999 to
$2.0 million for fiscal 2000. These amounts represented 43% and 20% of license and royalty revenues for the respective periods. The decrease in cost of license and royalty revenues in dollar
amounts was primarily due to a one-time credit received from a third-party vendor related to maintenance and support and lower costs related to the final amortization of certain prepaid
in-bound licenses.

Service.Cost of service revenues increased 164% from $8.2 million for fiscal 1999 to $21.7 million for
fiscal 2000. These amounts represented 69% and 122% of service revenues for the respective periods. This increase reflected our continued investment in our professional services organization necessary
to meet growing customer service needs, as well as an increase in the level of billable custom development projects.

Operating Expenses

Research and Development.Research and development expenses increased 78% from $18.2 million for fiscal 1999 to
$32.3 million for fiscal 2000. These amounts represented 105% and 115% of total revenues for the respective periods. The increase in dollar amounts and as a percentage of total revenues was
primarily due to higher personnel and related expenses resulting from increases in staffing, use of external contractors, and outsourced development projects, in particular a project with Motorola.

Sales and Marketing.Sales and marketing expenses increased 60% from $11.7 million for fiscal 1999 to
$18.7 million for fiscal 2000. These amounts represented 68% and 67% of total revenues for the respective periods. The increase in absolute dollar amounts was primarily due to increased
employee-related expenses, including higher headcount, commission costs, and travel-related expenses. Also contributing to the increase were our PopTV program and our increased tradeshow presence.

General and Administrative.General and administrative expenses increased 97% from $4.0 million for fiscal 1999
to $7.8 million for fiscal 2000. These amounts represented 23% and 28% of total revenues for the respective periods. The increase in dollar amounts and as a percentage of total revenues was
primarily due to increased staffing, including the formation of our corporate development organization, the establishment of the infrastructure necessary to support our obligations as a public
company, and merger termination costs of $624,000. In addition, we incurred costs related to our expansion into international markets.

Amortization of Purchased Intangibles.We recorded $6.1 million of amortization expense for fiscal 1999 and
$22.1 million of amortization expense for fiscal 2000, related to the acquisition of SourceSuite in March 2000.

Amortization of Warrants.We recorded warrant amortization expense of $18,000 and $10.8 million for fiscal 1999
and fiscal 2000, respectively, related to the increased number of warrants earned.

Amortization of Deferred Stock Compensation.Amortization of deferred stock compensation was $507,000 for fiscal 1999
compared to $2.1 million for fiscal 2000. The majority of the stock option grants being amortized were granted in the latter half of fiscal 1999.

Acquired In-Process Research and Development.We did not record expense for acquired in-process
research and development in fiscal 1999. In fiscal 2000, we expensed $1.9 million of acquired in-process research and development in connection with the SourceSuite acquisition
that, in the opinion of

31

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management, had not reached technological feasibility and had no alternative future use. See Note 4 of Notes to Consolidated Financial Statements.

Interest Income

Interest income increased from $80,000 for fiscal 1999 to $11.6 million for fiscal 2000. The increase was primarily due to interest income on proceeds
from our private placement in May 1999, our IPO of common stock in July 1999, and our secondary offering in February 2000.

Other Income (Expense), Net

Other income (expense), net increased from $21,000 for fiscal 1999 to $847,000 for fiscal 2000. The increase was primarily due to foreign currency exchange
gain and losses and losses resulting from disposals of fixed assets.

Income Tax Provision (Benefit)

Income tax provision (benefit) decreased from an income tax benefit of $586,000 for fiscal 1999 to an income tax provision of $137,000 for fiscal 2000. For
fiscal 1999, our income tax benefit was comprised of the benefits received under a tax-sharing agreement with Oracle that provides for our consolidation into Oracle's tax group for certain
state income tax payment purposes. Since the effective date of our IPO, upon which Oracle's ownership percentage was reduced to less than 50%, our results are no longer included in any of Oracle's
consolidated state tax returns and we no longer receive a tax benefit from Oracle. Income tax provision for fiscal 2000 consisted primarily of foreign withholding tax expense. See Note 10 of
Notes to Consolidated Financial Statements.

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Quarterly Results of Operations

The following table (in thousands) sets forth unaudited consolidated quarterly financial data from the periods indicated. We derived this table from our
consolidated financial statements, and, in our opinion, it includes all adjustments, which consist only of normal recurring adjustments, necessary to present fairly the financial results for the
periods. Results of operations for any previous fiscal quarter do not necessarily indicate what results may be for any future period.

|                                            |                                              | Quarter Ended                    |     
|------------------------------------------- | -------------------------------------------- | -------------------------------- | ----
|
|Consolidated Statements of Operations Data: |                                              |                                  |     
|REVENUES:                                   |                                              |                                  |     
|                                            | License and royalty                          |                                  | $   
|                                            | Service                                      |                                  |     
|                                            |                                              |                                  |     
|                                            |                                              | Total revenues                   |     
|                                            |                                              |                                  |     
|COST OF REVENUES:                           |                                              |                                  |     
|                                            | License and royalty                          |                                  |     
|                                            | Service                                      |                                  |     
|                                            |                                              |                                  |     
|                                            |                                              | Total cost of revenues           |     
|                                            |                                              |                                  |     
|                                            |                                              | Gross margin                     |     
|                                            |                                              |                                  |     
|OPERATING EXPENSES:                         |                                              |                                  |     
|                                            | Research and development                     |                                  |     
|                                            | Sales and marketing                          |                                  |     
|                                            | General and administrative                   |                                  |     
|                                            | Amortization of purchased intangibles        |                                  |     
|                                            | Amortization of warrants                     |                                  |     
|                                            | Amortization of deferred stock compensation  |                                  |     
|                                            | Acquired in-process research and development |                                  |     
|                                            |                                              |                                  |     
|                                            |                                              | Total operating expenses         |     
|                                            |                                              |                                  |     
|                                            |                                              | Loss from operations             |     
|INTEREST INCOME                             |                                              |                                  | 995 
|OTHER INCOME (EXPENSE), net                 |                                              |                                  | (298
|                                            |                                              |                                  |     
|                                            |                                              | Loss before income tax provision |     
|INCOME TAX PROVISION                        |                                              |                                  | 41  
|                                            |                                              |                                  |     
|                                            |                                              | Net loss                         |     
|                                            |                                              |                                  |     

LIQUIDITY AND CAPITAL RESOURCES

Our principal source of liquidity was cash and cash equivalents of $127.0 million and short-term investments of $149.2 million.
Additionally, as of May 31, 2001, we had $184.8 million in long-term investments. Prior to May 31, 2001, we funded our operations as follows:



33

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For
fiscal 1999, net cash used in operating activities of $6.5 million was comprised of a net loss of $33.1 million, offset by $15.4 million of deferred revenues,
$6.1 million of amortization of purchased intangibles, and $4.5 million if accrued liabilities.

For
fiscal 2000, net cash used in operating activities of $16.8 million was comprised of a net loss of $80.8 million and $3.7 million of prepaid expenses and
other current assets, offset by $28.3 million of deferred revenues, $22.1 million of amortization of purchased intangibles, $10.8 million of amortization of warrants,
$2.2 million of depreciation and amortization, and $2.1 million of accrued payroll and related expenses.

For
fiscal 2001, net cash used in operating activities of $62.0 million was comprised of a net loss of $306.4 million, $14.9 million of deferred revenues,
$8.1 million of accounts receivable, $4.7 million of accrued liabilities, and $3.2 million of prepaid expenses, offset by $216.1 million of amortization of purchased
intangibles, $23.2 million of amortization of warrants, $22.4 million of write-offs of acquired in-process research and development, $5.5 million of
depreciation and amortization, and $5.3 million of write-offs of equity investments.

For
fiscal 1999, net cash used in investing activities of $21.4 million was comprised of purchases of short-term investments and purchases property and equipment.

For
fiscal 2000, net cash used in investing activities of $297.6 million was comprised of $379.2 million of purchases of investments, $10.9 million of purchases
of property and equipment for our new facilities, $8.8 million of restricted cash, and $4.0 million of purchases of equity investments, offset by $105.3 million of proceeds from
maturities of investments.

For
fiscal 2001, net cash used in investing activities of $51.6 million was comprised of $488.6 million of purchases of investments, $11.5 million of purchases of
property and equipment, and $11.2 million of purchases of equity investments, offset by $458.3 million of proceeds from maturities of investments.

For
fiscal 1999, net cash provided by financing activities of $49.4 million was comprised of $47.8 million of proceeds from issuance of convertible preferred stock in
May 1999 and $1.5 million of proceeds from the issuance of common stock to employees through our stock option plan.

For
fiscal 2000, net cash provided by financing activities of $413.6 million was comprised of $297.2 million of proceeds from our secondary public offering in
January 2000, $97.8 million of proceeds from our IPO in July 1999, $12.5 million of proceeds from our private placement in July 1999, and $6.4 million of
proceeds from issuance of common stock to employees through our stock option plan and our employee stock purchase plan.

For
fiscal 2001, net cash provided by financing activities of $107.1 million was comprised of $100.0 million of proceeds from our private placement in July, 2000, and
$7.8 million attributable to the issuance of common stock to employees through our stock option plan and our employee stock purchase plan.

As
of May 31, 2000 and 2001, our outstanding short- and long-term obligations were $2.5 million and $2.4 million, respectively, and consisted
primarily of deferred rent expense and capital lease commitments. We did not have any material commitments for capital expenditures. We anticipate that our capital expenditures for fiscal 2002 will be
less than that for fiscal 2001.

34

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Under a development agreement entered into with Motorola in April 1999, we are committed to pay $10.0 million in development fees for certain services to be performed by
Motorola. These fees are being paid out over a three-year period, and $5.0 million had been paid as of May 31, 2001.

During
fiscal 2001, we renegotiated our Technology License and Distribution Agreement with Sun Microsystems. The new agreement eliminated the guaranteed royalties and support fees of
$3.8 million. In exchange for the elimination of the guarantees, we agreed to pay royalty and support fees for the licenses, and royalties as we use the underlying licenses. In fiscal 2001, we
prepaid $1.4 million in royalties and support to Sun Microsystems. None of the prepaid licenses had been used as of May 31, 2001. Royalty and support expenses related to these agreements
were $250,000 for fiscal 1999, $583,000 for fiscal 2000, and $623,000 for fiscal 2001.

As
of May 31, 2001, through the Liberate Corporate Venture Fund, we had invested $15.2 million in our portfolio of companies, with $4.0 million invested in fiscal
2000, and $11.2 million invested in fiscal 2001. In the fourth quarter of fiscal 2001, we wrote down $5.3 million of equity investments that had been permanently impaired, reducing our
net equity investments to $9.9 million as of May 31, 2001. In June 2001, we committed to invest $2.0 million in China Broadband (H.K.) for reinvestment in China New
Broadband Video and Communications, a Chinese joint venture that makes interactive television software. The investment will be made in five phases over the next year, based upon the achievement of
specific technical and commercial milestones. The first investment of $750,000 was made in June 2001. We plan to continue to identify additional opportunities to make strategic investments.

In
January 2001, we extended loans in exchange for promissory notes from Coleman Sisson, our President and Chief Operating Officer, and David Limp, our Executive Vice President
and Chief Strategy Officer. In April 2001, we extended a loan in exchange for a promissory note from Donald Fitzpatrick, our Executive Vice President, Sales and Service. Each loan is in the
amount of $500,000 at 5.9% compounded annually and is due and payable two years from issuance.

In
January 2001, we also entered into employee retention agreements with Mr. Sisson, Mr. Fitzpatrick, and Mr. Limp. Each retention agreement provides
approximately $820,000 to the employee over the next two years of continued service.

As
of May 31, 2001, we had commitments, under a binding Letter of Understanding, for up to $5.0 million related to potential future marketing activities. These amounts
will be expensed when and if incurred.

In
addition to normal operating expenses, we anticipate requiring cash for financing growth, payment of outstanding commitments, and the acquisition of products and technologies to
complement our existing business. We believe that the net proceeds from our various offerings, together with cash and cash equivalents generated from operations, if any, will be sufficient to meet our
working capital requirements through May 31, 2002. However, there can be no assurances that additional financing will be available to us on favorable terms, if at all.

VALUATION OF IN-PROCESS RESEARCH AND DEVELOPMENT

In connection with our acquisitions of SourceSuite and MoreCom, we had outside appraisal firms perform valuations of the acquired companies that were used as
aids in determining the fair value of the identifiable assets and in allocating the purchase price among the acquired assets, including the portion of the purchase price attributed to
in-process research and development. Assets identified generally included in-process research and development, developed technology, assembled workforce, installed customer
base, and goodwill.

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SourceSuite Acquisition

Our appraisers allocated the purchase price of the assets acquired in the SourceSuite acquisition by identifying assets through interviews with SourceSuite
management, reviewing data for comparable companies, and assessing SourceSuite's financial plans. The assets that were identified consisted primarily of existing technology, assembled workforce,
in-process research and development, trademarks, and goodwill.

The
value of SourceSuite's in-process technology, existing technology, and trademarks was determined based on the income approach, which measures the present worth and
anticipated future benefits of the intangible asset. The approach allocates revenue to existing and future technology, deducts appropriate expenses and economic rents, charges for the use of other
assets, and then calculates a present value of after-tax cash flows attributable to the technology. In the case of in-process technology, the cost to complete the technology is
not deducted and the cash flows are multiplied by the percentage of completion of each project. Revenue was allocated to the technology by estimating the number of man-years invested in
both the existing and in-process technology, discounted by the projected obsolescence of each technology. The percentage of completion of each project was determined by dividing the number
of man-years invested as of the valuation date by the estimated total number of man-years to completion. A weighted average cost of capital was calculated by applying the
Capital Asset Pricing Model to comparable public companies, using a discount rate of 25% to value the existing technology, and a discount rate of 30% to value the in-process technology
(taking into account the additional risk associated with the technology).

The
assembled workforce was valued using the cost approach, using the estimated cost to recruit and train a comparable workforce.

MoreCom Acquisition

Our appraisers allocated the purchase price of the assets acquired in the MoreCom acquisition by identifying assets through interviews with MoreCom management,
reviewing data for comparable companies, and assessing MoreCom's financial plans. The assets that were identified consisted primarily of existing technology, assembled workforce,
in-process research and development, trademarks, and goodwill.

The
value of MoreCom's in-process research and development was determined primarily on the basis of the income approach. Under this approach, the fair value of the
in-process research and development reflects the present value of the projected free cash flows that will be generated by the in-process research and development projects and
that is attributable to the acquired technology, if successfully completed. The income approach focuses on the income-producing capability of the acquired technology, and best represents the present
value of the future economic benefits expected to be derived from them, and therefore, the fair value of the acquired technology. The projected revenues used in the income approach are based upon the
revenues likely to be generated upon the completion
of the projects and the beginning of commercial sales, as estimated by management. The projections assume that the products will be successful and that the products' development and commercialization
meet management's current time schedule. In arriving at the appropriate discount rates, the implied rate of the transaction and the weighted average cost of capital were considered. The discount rate
applicable to the in-process project reflects the risks inherent in each project. An overall after-tax discount rate of 20% was applied to the project's cash flows. The
required returns of other assets were deducted from the incremental cash flows generated by the projects shown in the in-process research and development model to determine the incremental
cash flows specifically attributable to the in-process research and development project.

The
value of MoreCom's patents was developed primarily on the basis of the replacement cost approach. Under this method, the fair value of an asset is equal to the cost to replace the
functionality

36

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of the asset. In the case of patents, the replacement cost of the asset is equal to the royalty that would have to be paid for the right to use the patents if they were not acquired by us. Because we
acquired the patents, we were relieved from making royalty payments. As such, a relief-from-royalty method was used to apply the replacement cost approach. To apply the
relief-from-royalty method, an appropriate royalty rate was determined and applied to the expected sales of products associated with the patents.

The
customer relationships and assembled workforce were valued using the cost approach. Under this approach, the value is calculated based on the costs we avoided through obtaining
the relationships and workforce from the acquired party rather than incurring the costs to assemble them independently. Therefore, the fair value of the acquired customer relationships was calculated
as the costs which we avoided spending in recreating similar functional customer relationships. Similarly, the assembled workforce was valued by calculating the costs we avoided by obtaining a
pre-existing, trained, and fully efficient team rather than incurring the costs to assemble this workforce.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting For Derivative Instruments And Hedging
Activities." SFAS No. 133 establishes accounting and reporting standards for derivative financial instruments and hedging activities related to those instruments, as well as other hedging
activities. We will adopt SFAS No. 133 effective June 1, 2001.We do not expect that the adoption of SFAS No. 133 will have a
material impact on our financial position, results of operations, or cash flows.

In
March 2000, the FASB issued Interpretation ("FIN") No. 44, "Accounting For Certain Transactions Involving Stock CompensationAn Interpretation Of APB
Opinion No. 25." This interpretation provides guidance regarding the application of APB No. 25 to stock compensation involving employees. The
adoption of FIN No. 44 was effective July 1, 2000 and did not have a material impact on Liberate's financial position or results of operations.

In
July 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangibles." SFAS No. 141 requires all business
combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. Under SFAS No. 142, goodwill is no longer subject to amortization over its
estimated useful life. Prospectively, goodwill is subject to at least an annual assessment for impairment applying a fair-value-based test. Additionally, an acquired intangible asset
should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or
exchanged, regardless of the acquirer's intent to do so. As of May 31, 2001, we had $432.2 million of purchased intangibles recorded on its balance sheet, net of accumulated
amortization. Of this balance, approximately $426.1 million related to goodwill and the remainder was comprised of other purchased intangibles, including patents, trademarks, existing
technology, customer relationships, and assembled workforce. Upon adoption of SFAS No. 142 on June 1, 2002, we will cease to amortize goodwill, thereby eliminating annual goodwill
amortization expense of approximately $217.7 million based on anticipated amortization expense for fiscal 2002. Total amortization expense for goodwill and purchased intangibles for fiscal 2001
was $216.1 million, of which approximately $213.0 million related to goodwill.

In
August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 establishes financial accounting and reporting
obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement will be effective in fiscal 2004. We have not yet
assessed the impact of adopting SFAS No. 143.

37

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ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

As of May 31, 2001, our investment portfolio includes $324.0 million of U.S. government obligations, commercial paper, and other corporate
securities, that may increase or decrease in value if interest rates change prior to maturity. We do not use derivative financial instruments in our investment portfolio. We place our investments only
with quality issuers who carry high credit ratings, and by policy, limit the amount of credit exposure to any one issuer. We are averse to principal loss and seek to preserve our invested funds by
limiting the fault risk, market risk, and reinvestment risk. We currently maintain sufficient cash and cash equivalent balances to typically hold our investments to
maturity. An immediate 10% change in interest rates would be immaterial to our financial condition or results of operations.

Foreign Currency

We transact business in various foreign currencies and, accordingly, are subject to adverse movements in foreign currency exchange rates. To date, the effect
of changes in foreign currency exchange rates on revenues and operating expenses has not been material, as the majority of our revenues are earned in U.S. dollars. Operating expenses incurred by our
foreign subsidiaries are denominated primarily in European currencies. We do not currently use financial instruments to hedge these operating expenses, but we continue to assess the need to use
financial instruments to hedge currency exposures.

The
following is a summary of investments (in thousands):

|                                      |  | As of May 31, 2001
|------------------------------------- |  | ------------------
|
|Money market                          |  | $                 
|Commercial paper                      |  |                   
|Government notes and bonds            |  |                   
|Corporate notes and bonds             |  |                   
|Market auction preferredstaxable     |  |                   
|Equity securities                     |  |                   
|                                      |  |                   
|                                      |  | $                 
|                                      |  |                   
|Included in cash and cash equivalents |  | $                 
|Included in short-term investments    |  |                   
|Included in long-term investments     |  |                   
|                                      |  |                   
|                                      |  | $                 
|                                      |  |                   

38

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Pages 46 through 73 present our consolidated financial statements, including our consolidated balance sheets as of May 31, 2000 and 2001; our
consolidated statements of operations and comprehensive loss, consolidated statements of stockholders' equity, and consolidated statements of cash flows for the year ended May 31, 1999, 2000,
and 2001; and our notes to consolidated financial statements, together with a report thereon of Arthur Andersen LLP, dated June 21, 2001.

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

None.

PART III.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information concerning our directors required by this Item is incorporated by reference to the section titled "Proposal No. 1Election
of Directors" in our Proxy Statement for the 2001 Annual Meeting of Stockholders ("2001 Proxy Statement").

The
information concerning our executive officers required by this Item is incorporated by reference to the section titled "Executive Officers" in Item 1 of this
Form 10-K.

The
information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is incorporated by reference to the section titled
"Section 16(a) Beneficial Ownership Reporting Compliance" in our 2001 Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

The response to this Item will be contained in the 2001 Proxy Statement under the heading "Executive Compensation and Related Information" and is incorporated
herein by reference.

ITEM 12. STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The response to this Item will be contained in the 2001 Proxy Statement under the heading "Stock Ownership of Certain Beneficial Owners and Management" and is
incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The response to this Item will be contained in the 2001 Proxy Statement under the heading "Certain Relationships and Related Transactions" and is incorporated
herein by reference.

39

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PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)Exhibits

|Exhibit No. |  | Description                                                                                                                                                                                                                                                                              
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1         |  | Agreement and Plan of Merger, dated May 16, 1997, between Liberate and Navio. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)                                                          
|2.2         |  | Merger Agreement and Plan of Reorganization with SourceSuite LLC, dated January 12, 2000. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg.
No. 333-95139).)                                              
|2.3         |  | Plan and Agreement of Reorganization with MoreCom, Inc., dated March 27, 2000. (Incorporated by reference to similarly numbered exhibit to the Form 8-K filed by the Registrant on July 7, 2000).                                                                                        
|2.4         |  | Amendment No. 1 to Plan and Agreement of Reorganization with MoreCom, Inc. (Incorporated by reference to similarly numbered exhibit to the Form 8-K filed by the Registrant on July 7, 2000).                                                                                            
|3.1         |  | Amended and Restated Bylaws of Liberate. (Incorporated by reference to Exhibit 3.4 to the Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-78781).)                                                                                                              
|3.2         |  | Sixth Amended and Restated Certificate of Incorporation of Liberate. (Incorporated by reference to Exhibit 3.5 to the Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-78781).)                                                                                  
|4.1         |  | Specimen Certificate of Liberate's common stock. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-78781).)                                                                                       
|9.1         |  | Voting Agreement, dated May 12, 1999, among Liberate, Oracle, Comcast Technology, Cox Communications and MediaOne Interactive Services. (Incorporated by reference to similarly numbered exhibit to the Registration
Statement on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
|9.2         |  | Amendment to Voting Agreement, dated December 11, 2000. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on January 12, 2001).                                                                                                          
|9.3         |  | Irrevocable Trust Agreement between Delphi Asset Management Corporation, United States Trust Company of New York, and US Trust Company of Delaware, effective as of January 23, 2001.                                                                                                    
|9.4         |  | Standstill Agreement between Liberate, Delphi Asset Management Corporation, US Trust Company of Delaware, and United States Trust Company of New York, entered into as of January 23, 2001.                                                                                              
|10.1        |  | Form of Indemnification Agreement entered into between Liberate and its directors and executive officers.*                                                                                                                                                                               
|10.2        |  | Network Computer, Inc. 1996 Stock Option Plan, and form of Option Agreement. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)                                                           
|10.3        |  | Navio Communications, Inc. 1996 Stock Option Plan and form of Option Agreement. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)                                                        

40

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|10.4  |  | Navio Communcations, Inc. Non-Qualified Option Plan, and form of Option Agreement. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)                                         
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.5  |  | 1999 Equity Incentive Plan. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-78781).)                                                                                                
|10.6  |  | 1999 Employee Stock Purchase Plan. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-78781).)                                                                                         
|10.7  |  | Employment Agreement between Liberate and Mitchell E. Kertzman, dated October 12, 1998, as amended, and January 5, 2000. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1
filed by the Registrant (Reg. No. 333-95139).)*  
|10.13 |  | OEM License Agreement, dated December 31, 1997, between Liberate and Wind River Systems, as amended. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the
Registrant (Reg. No. 333-78781).)                       
|10.14 |  | Technology License Agreement, dated September 8, 1998, between Liberate and Oracle. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-
78781).)                                       
|10.15 |  | Letter Agreement, dated May 16, 1997, among Liberate, Oracle, and Netscape. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.333-78781).)                                                 
|10.16 |  | Source Code License Agreement, dated July 9, 1996, between Netscape and TVSoft, as amended. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg.
No. 333-78781).)                                
|10.17 |  | OEM License Agreement, dated October 17, 1996, between Oracle and Netscape, as amended. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)                                    
|10.18 |  | Cooperation Agreement, dated July 1, 1999, between Liberate and Intel, as amended. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)                                         
|10.20 |  | Convertible Promissory Note Purchase Agreement, dated November 12, 1997, entered between Liberate and Middlefield Ventures. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form
S-1 filed by the Registrant (Reg. No. 333-78781).)
|10.21 |  | Stockholders Agreement, dated August 11, 1997, among Liberate and the investors named therein. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)                             
|10.22 |  | Admission Agreement, dated November 12, 1997, among Liberate and the investors named therein. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333-78781).)                              
|10.29 |  | Circle Star Lease Agreement for San Carlos office space, dated April 27, 1999. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)                                             
|10.31 |  | Tax Allocation and Indemnity Agreement, dated August 17, 1997, between Liberate and Oracle. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg.
No. 333-78781).)                                

41

---

|10.32 |  | Network Computer, Inc. Stock Option Agreement, dated October 15, 1998, with David Roux. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)*                        
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.33 |  | Network Computer, Inc. Stock Option Agreement, dated October 15, 1998, with Mitchell Kertzman. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant
(Reg. No. 333- 78781).)*                
|10.34 |  | Series E Preferred Stock Purchase Agreement, dated May 12, 1999, among Liberate and the investors names therein. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by
the Registrant (Reg. No. 333-78781).)
|10.35 |  | Stock Purchase Agreement, dated June 30, 1999, among Liberate and Lucent Technologies Inc. (Incorporated by reference to similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg.
No. 333-78781).)                      
|10.37 |  | Master Lease Agreement, dated August 2, 1999, with Steelcase Financial Services, Inc. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on October 13, 1999).                                                     
|10.38 |  | Irrevocable Letter of Credit dated September 3, 1999 and Standby Letter of Credit Agreement. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on October 13,
1999).                                              
|10.39 |  | Employment letter between Liberate and Coleman Sisson, dated November 5, 1999. (Incorporated by reference to Exhibit 10.39 to the Form 10-Q filed by the Registrant on January 14, 2000).*                                                                        
|10.42 |  | Amendment to Employment Agreement between Liberate and Coleman Sisson, dated February 28, 2000. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on April 13,
2000).*                                            
|10.43 |  | Stock Purchase Agreement dated July 16, 2000, between Cisco Systems, Inc. and Liberate. (Incorporated by reference to similarly numbered exhibit to the Form 8-K filed by the Registrant on July 28, 2000).                                                       
|10.44 |  | Employment letter between Liberate and Philip A. Vachon, dated June 30, 2000. (Incorporated by reference to similarly numbered exhibit to the Form 10-K filed by the Registrant on August 25, 2000).*                                                             
|10.45 |  | Employment Retention Agreement between Liberate and Coleman Sisson, dated January 8, 2001. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on January 12,
2001).*                                               
|10.46 |  | Employment Retention Agreement between Liberate and David Limp, dated January 9, 2001. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on January 12, 2001).*                                                   
|10.47 |  | Employment Retention Agreement between Liberate and Donald Fitzpatrick, dated January 3, 2001. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on January 12,
2001).*                                           
|10.48 |  | Promissory Note, dated January 8, 2001, for loan extended to Coleman Sisson. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on January 12, 2001).*                                                             
|10.49 |  | Promissory Note, dated January 3, 2001, for loan extended to David Limp. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on January 12, 2001).*                                                                 

42

---

|10.50 |  | Promissory Note, dated April 6, 2001, for loan extended to Don Fitzpatrick. (Incorporated by reference to similarly numbered exhibit to the Form 10-Q filed by the Registrant on April 13, 2001).*
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.51 |  | Settlement and Mutual Release Agreement between Charitable Way, Inc. and Liberate, entered into as of May 17, 2001.                                                                               
|10.52 |  | Amendment to Employment Agreement between Liberate and Philip A. Vachon, dated November 15, 2000.*                                                                                                
|10.53 |  | Form of Executive Officer Option Grant Notice under the 1999 Equity Incentive Plan, effective for grants made on April 12, 2001 and later.*                                                       
|21.1  |  | Subsidiaries of Liberate.                                                                                                                                                                         
|23.1  |  | Consent of Independent Public Accountants, Arthur Andersen LLP.                                                                                                                                   

---

*
Management contract or compensatory plan or arrangement.

Schedules
not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto.



43

---



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 24th day of August, 2001:

| |  | LIBERATE TECHNOLOGIES
| |  | ---------------------
| |  | By:                  

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the
24th day of August, 2001:

|Signature                                   |  | Title                                                                                         
|------------------------------------------- |  | ----------------------------------------------------------------------------------------------
|                                            |  |                                                                                               
|/s/MITCHELL E. KERTZMANMitchell E. Kertzman |  | Chief Executive Officer and Director
(Principal Executive Officer)                            
|/s/NANCY J. HILKERNancy J. Hilker           |  | Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting Officer)
|/s/DAVID J. ROUXDavid J. Roux               |  | Chairman of the Board of Directors                                                            
|/s/CHARLES N. CORFIELDCharles N. Corfield   |  | Director                                                                                      
|/s/DANA L. EVANDana L. Evan                 |  | Director                                                                                      
|/s/DR. DAVID C. NAGELDr. David C. Nagel     |  | Director                                                                                      

44

---



LIBERATE TECHNOLOGIES  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                             |  | Page
|------------------------------------------------------------ |  | ----
|Report of Independent Public Accountants                     |  | 46  
|Consolidated Balance Sheets                                  |  | 47  
|Consolidated Statements of Operations and Comprehensive Loss |  | 48  
|Consolidated Statements of Stockholders' Equity              |  | 49  
|Consolidated Statements of Cash Flows                        |  | 50  
|Notes to Consolidated Financial Statements                   |  | 51  
|Valuation and Qualifying Accounts                            |  | 74  

45

---



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To
the Board of Directors and Stockholders of
Liberate Technologies:

We
have audited the accompanying consolidated balance sheets of Liberate Technologies (a Delaware corporation) and subsidiaries as of May 31, 2000 and 2001, and the related
consolidated statements of operations and comprehensive loss, stockholders' equity and cash flows for each of the three years in the period ended May 31, 2001. These financial statements and
the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

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

In
our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Liberate Technologies and subsidiaries as of
May 31, 2000 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended May 31, 2001 in conformity with accounting principles
generally accepted in the United States.

Our
audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in the index to financial statements is
presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein
in relation to the basic consolidated financial statements as a whole.



San
Jose, California
June 21, 2001

46

---



LIBERATE TECHNOLOGIES  CONSOLIDATED BALANCE SHEETS  (In thousands, except share and per share data)

|                                       |                                                                                                                                                              | May 31,                                    |       
|-------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | ------
|
|ASSETS                                 |                                                                                                                                                             
|CURRENT ASSETS:                        |                                                                                                                                                              |                                            |       
|                                       | Cash and cash equivalents                                                                                                                                    |                                            | $     
|                                       | Short-term investments                                                                                                                                       |                                            |       
|                                       | Accounts receivable, net of allowance for doubtful accounts of $436 in 2000
and $493 in 2001                                                                 |                                            |       
|                                       | Receivable from affiliate                                                                                                                                    |                                            |       
|                                       | Prepaid expenses and other current assets                                                                                                                    |                                            |       
|                                       |                                                                                                                                                              |                                            |       
|                                       |                                                                                                                                                              | Total current assets                       |       
|PROPERTY AND EQUIPMENT, net            |                                                                                                                                                              |                                            | 12,759
|OTHER ASSETS:                          |                                                                                                                                                              |                                            |       
|                                       | Restricted cash                                                                                                                                              |                                            |       
|                                       | Long-term investments                                                                                                                                        |                                            |       
|                                       | Purchased intangibles, net                                                                                                                                   |                                            |       
|                                       | Warrants                                                                                                                                                     |                                            |       
|                                       | Notes receivable from officers                                                                                                                               |                                            |       
|                                       | Other                                                                                                                                                        |                                            |       
|                                       |                                                                                                                                                              |                                            |       
|                                       |                                                                                                                                                              | Total assets                               |       
|                                       |                                                                                                                                                              |                                            |       
|LIABILITIES AND STOCKHOLDERS' EQUITY   |                                                                                                                                                             
|CURRENT LIABILITIES:                   |                                                                                                                                                              |                                            |       
|                                       | Accounts payable                                                                                                                                             |                                            | $     
|                                       | Accrued payroll and related expenses                                                                                                                         |                                            |       
|                                       | Accrued liabilities                                                                                                                                          |                                            |       
|                                       | Current portion of capital leases                                                                                                                            |                                            |       
|                                       | Deferred revenues                                                                                                                                            |                                            |       
|                                       |                                                                                                                                                              |                                            |       
|                                       |                                                                                                                                                              | Total current liabilities                  |       
|LONG-TERM LIABILITIES:                 |                                                                                                                                                              |                                            |       
|                                       | Long-term capital leases, net of current portion                                                                                                             |                                            |       
|                                       | Other long-term liabilities                                                                                                                                  |                                            |       
|                                       |                                                                                                                                                              |                                            |       
|                                       |                                                                                                                                                              | Total liabilities                          |       
|                                       |                                                                                                                                                              |                                            |       
|COMMITMENTS AND CONTINGENCIES (Note 6) |                                                                                                                                                              |                                            |       
|STOCKHOLDERS' EQUITY:                  |                                                                                                                                                              |                                            |       
|                                       | Common stock, $0.01 par value; Authorized200,000,000 shares; Outstanding90,927,732 shares and 104,702,095 shares as of May 31, 2000 and 2001, respectively |                                            |       
|                                       | Contributed and paid-in-capital                                                                                                                              |                                            |       
|                                       | Warrants                                                                                                                                                     |                                            |       
|                                       | Deferred stock compensation                                                                                                                                  |                                            |       
|                                       | Stockholder notes receivable                                                                                                                                 |                                            |       
|                                       | Accumulated other comprehensive income                                                                                                                       |                                            |       
|                                       | Accumulated deficit                                                                                                                                          |                                            |       
|                                       |                                                                                                                                                              |                                            |       
|                                       |                                                                                                                                                              | Total stockholders' equity                 |       
|                                       |                                                                                                                                                              |                                            |       
|                                       |                                                                                                                                                              | Total liabilities and stockholders' equity |       
|                                       |                                                                                                                                                              |                                            |       

The accompanying notes are an integral part of these consolidated financial statements.

47

---



LIBERATE TECHNOLOGIES  CONSOLIDATED STATEMENTS OF OPERATIONS  AND COMPREHENSIVE LOSS  (In thousands, except per share data)

|                                                  |                                              | Years Ended May 31,                        |       
|------------------------------------------------- | -------------------------------------------- | ------------------------------------------ | ------
|
|REVENUES:                                         |                                              |                                            |       
|                                                  | License and royalty                          |                                            | $     
|                                                  | Service                                      |                                            |       
|                                                  |                                              |                                            |       
|                                                  |                                              | Total revenues                             |       
|                                                  |                                              |                                            |       
|COST OF REVENUES:                                 |                                              |                                            |       
|                                                  | License and royalty                          |                                            |       
|                                                  | Service                                      |                                            |       
|                                                  |                                              |                                            |       
|                                                  |                                              | Total cost of revenues                     |       
|                                                  |                                              |                                            |       
|                                                  |                                              | Gross margin                               |       
|                                                  |                                              |                                            |       
|OPERATING EXPENSES:                               |                                              |                                            |       
|                                                  | Research and development                     |                                            |       
|                                                  | Sales and marketing                          |                                            |       
|                                                  | General and administrative                   |                                            |       
|                                                  | Amortization of purchased intangibles        |                                            |       
|                                                  | Amortization of warrants                     |                                            |       
|                                                  | Amortization of deferred stock compensation  |                                            |       
|                                                  | Acquired in-process research and development |                                            |       
|                                                  |                                              |                                            |       
|                                                  |                                              | Total operating expenses                   |       
|                                                  |                                              |                                            |       
|                                                  |                                              | Loss from operations                       |       
|INTEREST INCOME                                   |                                              |                                            | 80    
|OTHER INCOME (EXPENSE), net                       |                                              |                                            | (21   
|                                                  |                                              |                                            |       
|                                                  |                                              | Loss before income tax provision (benefit) |       
|INCOME TAX PROVISION (BENEFIT)                    |                                              |                                            | (586  
|                                                  |                                              |                                            |       
|                                                  |                                              | Net loss                                   |       
|FOREIGN CURRENCY TRANSLATION ADJUSTMENT           |                                              |                                            | 13    
|                                                  |                                              |                                            |       
|                                                  |                                              | Comprehensive loss                         |       
|                                                  |                                              |                                            |       
|BASIC NET LOSS PER SHARE                          |                                              | $                                          | (56.60
|                                                  |                                              |                                            |       
|SHARES USED IN COMPUTING BASIC NET LOSS PER SHARE |                                              |                                            | 584   
|                                                  |                                              |                                            |       

The
accompanying notes are an integral part of these consolidated financial statements.

48

---

LIBERATE TECHNOLOGIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)

|                                                                          |  | Convertible Preferred
Stock |   |   |      |   |             |  |   |       |  |   |           |   |   |         |   |   |        |   |  
|------------------------------------------------------------------------- |  | --------------------------- | - | - | ---- | - | ----------- |  | - | ----- |  | - | --------- | - | - | ------- | - | - | ------ | - | -
|
|
|
|BALANCE, MAY 31, 1998                                                     |  | 53,997,646                  |   | $ | 540  |   | 426,656     |  | $ | 4     |  | $ | 109,990   |   | $ |        |   | $ |       |   | $
|Issuance of stock related to stock option exercises                       |  | 1,541,100                   |   |   | 16   |   | 807,688     |  |   | 8     |  |   | 2,181     |   |   |        |   |   |       |   |  
|Issuance of convertible preferred stock, net                              |  | 10,416,652                  |   |   | 104  |   |            |  |   |      |  |   | 47,386    |   |   |        |   |   |       |   |  
|Issuance of warrants                                                      |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   | 1,522   |   |   |       |   |  
|Deferred stock compensation related to stock options                      |  |                            |   |   |     |   |            |  |   |      |  |   | 7,086     |   |   |        |   |   | (7,086 | ) |  
|Amortization of deferred stock compensation compensation                  |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   | 507    |   |  
|Translation gain                                                          |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   |       |   |  
|Net loss                                                                  |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   |       |   |  
|                                                                          |  |                             |   |   |      |   |             |  |   |       |  |   |           |   |   |         |   |   |        |   |  
|BALANCE, MAY 31, 1999                                                     |  | 65,955,398                  |   |   | 660  |   | 1,234,344   |  |   | 12    |  |   | 166,643   |   |   | 1,522   |   |   | (6,579 | ) |  
|Issuance of stock related to stock option exercises and ESPP              |  | 233,810                     |   |   | 2    |   | 2,748,374   |  |   | 28    |  |   | 5,995     |   |   |        |   |   |       |   |  
|Conversion of preferred stock to common stock                             |  | (66,189,208                 | ) |   | (662 | ) | 66,189,208  |  |   | 662   |  |   |          |   |   |        |   |   |       |   |  
|Issuance of common stock related to the initial public offering, net      |  |                            |   |   |     |   | 13,402,100  |  |   | 134   |  |   | 97,703    |   |   |        |   |   |       |   |  
|Issuance of common stock related to convertible debt                      |  |                            |   |   |     |   | 843,880     |  |   | 8     |  |   | 4,335     |   |   |        |   |   |       |   |  
|Issuance of common stock related to private placement, net                |  |                            |   |   |     |   | 1,627,604   |  |   | 16    |  |   | 12,484    |   |   |        |   |   |       |   |  
|Issuance of common stock related to secondary offering, net               |  |                            |   |   |     |   | 2,890,000   |  |   | 29    |  |   | 297,181   |   |   |        |   |   |       |   |  
|Issuance of common stock related to SourceSuite acquisition               |  |                            |   |   |     |   | 1,772,000   |  |   | 18    |  |   | 190,528   |   |   |        |   |   |       |   |  
|Issuance of warrants                                                      |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   | 115,724 |   |   |       |   |  
|Deferred stock compensation related to stock options                      |  |                            |   |   |     |   |            |  |   |      |  |   | 1,057     |   |   |        |   |   | (1,057 | ) |  
|Amortization of deferred stock compensation                               |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   | 2,053  |   |  
|Issuance of common stock related to warrants exercised                    |  |                            |   |   |     |   | 220,222     |  |   | 2     |  |   | 27,474    |   |   | (27,476 | ) |   |       |   |  
|Translation gain                                                          |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   |       |   |  
|Net loss                                                                  |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   |       |   |  
|                                                                          |  |                             |   |   |      |   |             |  |   |       |  |   |           |   |   |         |   |   |        |   |  
|BALANCE, MAY 31, 2000                                                     |  |                            |   |   |     |   | 90,927,732  |  |   | 909   |  |   | 803,400   |   |   | 89,770  |   |   | (5,583 | ) |  
|Issuance of stock related to stock option exercises and ESPP              |  |                            |   |   |     |   | 2,167,201   |  |   | 22    |  |   | 7,721     |   |   |        |   |   |       |   |  
|Issuance of common stock related to private placement, net                |  |                            |   |   |     |   | 3,963,780   |  |   | 40    |  |   | 99,960    |   |   |        |   |   |       |   |  
|Issuance of common stock related to MoreCom acquisition                   |  |                            |   |   |     |   | 7,310,830   |  |   | 73    |  |   | 487,771   |   |   |        |   |   |       |   |  
|Reduction of deferred stock compensation related to employee terminations |  |                            |   |   |     |   |            |  |   |      |  |   | (612      | ) |   |        |   |   | 612    |   |  
|Amortization of deferred stock compensation                               |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   | 1,884  |   |  
|Paydown of note                                                           |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   |       |   |  
|Issuance of common stock related to warrants exercised                    |  |                            |   |   |     |   | 332,552     |  |   | 3     |  |   | 29,870    |   |   | (29,873 | ) |   |       |   |  
|Translation gain                                                          |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   |       |   |  
|Net loss                                                                  |  |                            |   |   |     |   |            |  |   |      |  |   |          |   |   |        |   |   |       |   |  
|                                                                          |  |                             |   |   |      |   |             |  |   |       |  |   |           |   |   |         |   |   |        |   |  
|BALANCE, MAY 31, 2001                                                     |  |                            |   | $ |     |   | 104,702,095 |  | $ | 1,047 |  | $ | 1,428,110 |   | $ | 59,897  |   | $ | (3,087 | ) | $
|                                                                          |  |                             |   |   |      |   |             |  |   |       |  |   |           |   |   |         |   |   |        |   |  

The accompanying notes are an integral part of these consolidated financial statements.

49

---



LIBERATE TECHNOLOGIES  CONSOLIDATED STATEMENTS OF CASH FLOWS  (In thousands)

|                                                     |                                                                             | Years Ended May 31,                                              |                                                      
|---------------------------------------------------- | --------------------------------------------------------------------------- | ---------------------------------------------------------------- | -----------------------------------------------------
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                |                                                                             |                                                                  |                                                      
|                                                     | Net loss                                                                    |                                                                  | $                                                    
|                                                     | Adjustments to reconcile net loss to net cash used in operating activities: |                                                                  |                                                      
|                                                     |                                                                             | Amortization of purchased intangibles                            |                                                      
|                                                     |                                                                             | Amortization of warrants                                         |                                                      
|                                                     |                                                                             | Depreciation and amortization                                    |                                                      
|                                                     |                                                                             | Write-off of acquired in-process research and development        |                                                      
|                                                     |                                                                             | Write-offs of equity investments                                 |                                                      
|                                                     |                                                                             | Non-cash compensation expense                                    |                                                      
|                                                     |                                                                             | Loss on disposal of property and equipment                       |                                                      
|                                                     |                                                                             | Provision for doubtful accounts                                  |                                                      
|                                                     |                                                                             | Changes in operating assets and liabilities, net of acquisition: |                                                      
|                                                     |                                                                             |                                                                  | Increase in accounts receivable                      
|                                                     |                                                                             |                                                                  | Increase in prepaid expenses and other current assets
|                                                     |                                                                             |                                                                  | Increase in notes receivable from officers           
|                                                     |                                                                             |                                                                  | (Increase) decrease in other assets                  
|                                                     |                                                                             |                                                                  | Increase (decrease) in accounts payable              
|                                                     |                                                                             |                                                                  | Increase (decrease) in accounts payable to affiliate 
|                                                     |                                                                             |                                                                  | Increase (decrease) in accrued liabilities           
|                                                     |                                                                             |                                                                  | Increase in accrued payroll and related expenses     
|                                                     |                                                                             |                                                                  | Increase (decrease) in deferred revenues             
|                                                     |                                                                             |                                                                  | Increase in interest payable                         
|                                                     |                                                                             |                                                                  | Increase in other long-term liabilities              
|                                                     |                                                                             |                                                                  |                                                      
|                                                     |                                                                             |                                                                  |                                                      
|                                                     |                                                                             |                                                                  |                                                      
|CASH FLOWS FROM INVESTING ACTIVITIES:                |                                                                             |                                                                  |                                                      
|                                                     | Purchases of investments                                                    |                                                                  |                                                      
|                                                     | Proceeds from maturities of investments                                     |                                                                  |                                                      
|                                                     | Purchases of property and equipment                                         |                                                                  |                                                      
|                                                     | Increase in restricted cash                                                 |                                                                  |                                                      
|                                                     | Cash acquired in MoreCom acquisition                                        |                                                                  |                                                      
|                                                     | Purchase of equity investments                                              |                                                                  |                                                      
|                                                     |                                                                             |                                                                  |                                                      
|                                                     |                                                                             |                                                                  |                                                      
|                                                     |                                                                             |                                                                  |                                                      
|CASH FLOWS FROM FINANCING ACTIVITIES:                |                                                                             |                                                                  |                                                      
|                                                     | Proceeds from secondary public offering, net                                |                                                                  |                                                      
|                                                     | Proceeds from initial public offering, net                                  |                                                                  |                                                      
|                                                     | Proceeds from private placement, net                                        |                                                                  |                                                      
|                                                     | Proceeds from issuance of common stock, net                                 |                                                                  |                                                      
|                                                     | Principal payments on capital lease obligations                             |                                                                  |                                                      
|                                                     | Repayment of notes payable                                                  |                                                                  |                                                      
|                                                     | Proceeds from issuance of convertible preferred stock, net                  |                                                                  |                                                      
|                                                     | Proceeds from notes payable                                                 |                                                                  |                                                      
|                                                     |                                                                             |                                                                  |                                                      
|                                                     |                                                                             |                                                                  |                                                      
|                                                     |                                                                             |                                                                  |                                                      
|EFFECT OF EXCHANGE RATE CHANGES ON CASH              |                                                                             |                                                                  | 13                                                   
|                                                     |                                                                             |                                                                  |                                                      
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |                                                                             |                                                                  | 21,519                                               
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR         |                                                                             |                                                                  | 12,138                                               
|                                                     |                                                                             |                                                                  |                                                      
|CASH AND CASH EQUIVALENTS, END OF YEAR               |                                                                             | $                                                                | 33,657                                               
|                                                     |                                                                             |                                                                  |                                                      
|SUPPLEMENTAL NON-CASH ACTIVITIES:                    |                                                                             |                                                                  |                                                      
|Conversion of debt and accrued interest to equity    |                                                                             | $                                                                |                                                     
|                                                     |                                                                             |                                                                  |                                                      
|Deferred stock compensation                          |                                                                             | $                                                                | 7,086                                                
|                                                     |                                                                             |                                                                  |                                                      
|Equipment acquired under capital lease               |                                                                             | $                                                                |                                                     
|                                                     |                                                                             |                                                                  |                                                      
|Issuance of stockholder notes receivable             |                                                                             | $                                                                | 322                                                  
|                                                     |                                                                             |                                                                  |                                                      
|SUPPLEMENTAL CASH ACTIVITIES:                        |                                                                             |                                                                  |                                                      
|Cash paid for interest                               |                                                                             | $                                                                |                                                     
|                                                     |                                                                             |                                                                  |                                                      
|Cash paid for income taxes                           |                                                                             | $                                                                | 48                                                   
|                                                     |                                                                             |                                                                  |                                                      

The accompanying notes are an integral part of these consolidated financial statements.

50

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LIBERATE TECHNOLOGIES        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  ORGANIZATION AND OPERATIONS OF THE COMPANY

Liberate Technologies ("Liberate" or "the Company") is a provider of standards-based software platforms for delivering enhanced content and services to
television viewers and consumers around the world. The Company began operations in late 1995 as a division of Oracle, developing client and server software for the consumer, enterprise, and
educational markets. In April 1996, the Company separately incorporated in Delaware as Network Computer, Inc. ("NCI"). On May 11, 1999, the Company changed its name from NCI to
Liberate Technologies.

We
have offices in North America, Europe, and Asia. Our headquarters and primary development offices are located in San Carlos, California. We have development offices in Murray City,
Utah; Horsham, Pennsylvania; and London, Ontario, Canada. We also have sales offices in London, England and Tokyo, Japan.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated
in consolidation.

Reclassifications

Certain reclassifications, none of which affected net income, have been made to prior year amounts to conform to the current year presentation.

Use of Estimates

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

Cash and Cash Equivalents, Investments and Restricted Cash

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company's investments are
classified as "held-to-maturity" given the Company's intent and ability to hold the investments to maturity. Held-to-maturity securities are stated at
amortized cost, including adjustments for amortization of premiums and accretion of discounts. As of May 31, 2000 and 2001, short-term investments consisted primarily of commercial
paper maturing at various dates.

51

---

The following is a summary of investments (in thousands):

|                                      |  | As of May 31, 2000
|------------------------------------- |  | ------------------
|
|Money market                          |  | $                 
|Commercial paper                      |  |                   
|Government notes and bonds            |  |                   
|Corporate notes and bonds             |  |                   
|Certificates of deposit               |  |                   
|Market auction preferreds-taxable     |  |                   
|Equity securities                     |  |                   
|                                      |  |                   
|                                      |  | $                 
|                                      |  |                   
|Included in cash and cash equivalents |  | $                 
|Included in short-term investments    |  |                   
|Included in long-term investments     |  |                   
|                                      |  |                   
|                                      |  | $                 
|                                      |  |                   

|                                      |  | As of May 31, 2001
|------------------------------------- |  | ------------------
|
|Money market                          |  | $                 
|Commercial paper                      |  |                   
|Government notes and bonds            |  |                   
|Corporate notes and bonds             |  |                   
|Market auction preferreds-taxable     |  |                   
|Equity securities                     |  |                   
|                                      |  |                   
|                                      |  | $                 
|                                      |  |                   
|Included in cash and cash equivalents |  | $                 
|Included in short-term investments    |  |                   
|Included in long-term investments     |  |                   
|                                      |  |                   
|                                      |  | $                 
|                                      |  |                   

In
September 1999, the Company entered into a new facilities operating lease agreement. As part of the agreement, the Company is required to hold a certificate of deposit to
secure an irrevocable letter of credit for its security deposit. As of May 31, 2001, the certificate of deposit amounted to $8.8 million and is included in restricted cash in the
accompanying consolidated balance sheet.

The
Company launched the Liberate Corporate Venture Fund in November 2000 to promote the development of interactive television and spur the growth of innovative companies. The
Venture Fund operates as a business group within Liberate. The Venture Fund's approach is to identify promising

52

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privately held companies that are in the mid-to-late stages of financing, have exceptional management teams, and have developed proven technologies. The fund seeks to aid the
development of the interactive television industry and give Liberate insight into leading-edge technologies and services in the interactive television industry, while also providing
reasonable financial returns. Liberate also expects to develop mutually beneficial commercial relationships with the companies in which it invests.

In
most cases, the Company plans to acquire a minority equity stake by co-investing with top-tier venture funds and does not intend to seek a seat on the
portfolio company's board of directors. Typically, the size of any investment will range between 15% and 25% of any given financing event. Given the appropriate opportunity, the Company may choose to
invest outside these parameters. As of May 31, 2001, Liberate had invested $15.2 million in its portfolio of companies, then comprised of DIVA Systems, Everypath, ICE, MetaTV, and Two
Way TV. In fiscal 2001, the Company wrote down $5.3 million of equity investments that had been permanently impaired, reducing its net equity investments to $9.9 million as of
May 31, 2001. The write-down is included in other expense in the accompanying consolidated statement of operations.

Long-Lived Assets

Liberate reviews long-lived assets, certain identifiable intangibles, and goodwill related to these assets for impairment in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-lived Assets and For Long-lived Assets to be Disposed Of."

Liberate
reviews assets to be held and used including purchased intangibles whenever events or changes in circumstances indicate that the carrying amount of a long-lived
asset may not be recoverable. The Company measures recoverability of assets by comparing their carrying amount to the future undiscounted cash flows that they are expected to generate. Impairment
reflects the amount by which the carrying value of the assets exceeds their fair market value.

Liberate
reports assets that it plans to dispose of, whether through sale or abandonment, at the lower of carrying value or fair market value less cost to sell. There were no plans to
sell or abandon any significant assets as of May 31, 2001.

Purchased Intangibles

Purchased intangibles consist of goodwill, assembled workforce, patents, and trademarks all related to the acquisitions accounted for using the purchase
method. Purchased intangibles, including goodwill, are being amortized on a straight-line basis over three years. Liberate believes the carrying value of its purchased intangibles reflects
the remaining economic lives of those intangibles as of May 31, 2001.
Management will continue to evaluate purchased intangibles, goodwill, and other long-lived assets for recoverability and impairment in accordance with SFAS No. 121. However, upon
adoption of SFAS No. 142, "Goodwill and Other Intangibles," the Company will cease to amortize goodwill. See "Recent Accounting Pronouncements" and Note 4.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to a concentration of credit risk consist principally of accounts receivable. As of May 31,
2000 and 2001, 66% and 62% of accounts receivable

53

---

were concentrated with three customers, respectively. The Company performs ongoing credit evaluations of its customers' financial conditions, and the risk of loss with respect to its accounts
receivable is further mitigated because its customer base is primarily comprised of well-established companies. The Company reserves for credit losses, which have been insignificant to
date.

Property and Equipment

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

Foreign Currency Translation

The functional currency of the Company's subsidiaries is the local currency. Accordingly, all assets and liabilities are translated into U.S. dollars at the
current exchange rate as of the applicable balance sheet date. Revenues and expenses are translated at the average exchange rate prevailing during the period.
Gains and losses resulting from the translation of the financial statements are reported as a separate component of stockholders' equity. Foreign currency transaction gains and losses are included in
other income (expense).

Software Development Costs

Under the criteria set forth in SFAS No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed," capitalization
of software development costs begins upon the establishment of technological feasibility of the product, which the Company has defined as the completion of beta testing of a working product. The
establishment of technological feasibility and the ongoing assessment of the recoverability of these costs require considerable judgment by management with respect to certain external factors,
including, but not limited to, anticipated future gross product revenues, estimated economic life, and changes in software and hardware technology. After considering these factors, Liberate has not
capitalized any software development costs to date.

Revenue Recognition

License and royalty revenues consist principally of fees earned from the licensing of the Company's software, as well as royalty fees earned upon the shipment
or activation of products that incorporate the Company's software. Liberate recognizes revenues from software license fees when the licensed product is delivered, collection is probable, the fee for
each element of the transaction is fixed and determinable, persuasive evidence of an arrangement exists, and vendor-specific objective evidence exists to allocate the total fee to all delivered and
undelivered elements of the arrangement. Portions of the revenue may be deferred in cases where the license arrangement calls for the future delivery of products or services for which the Company does
not have vendor-specific objective evidence to allocate a portion of the total fee to the undelivered element. In such cases, revenue is recognized when the undelivered elements are delivered or
vendor-specific objective evidence of the undelivered elements becomes available. However, if such undelivered elements consist of services that are essential to the functionality of the software, the
Company recognizes license and service revenues using contract accounting. If license arrangements include the rights to unspecified future products, revenue is

54

---

recognized over the contractual or estimated economic term of the arrangement. Royalty revenues are recognized when reported to the Company, which occurs after shipment or activation of the related
products. Prepaid royalties are deferred and recognized when reported.

Service
revenues consist of consulting, maintenance, and other services. The Company generally recognizes consulting and other service revenues, including non-recurring
engineering and training revenues, as services are performed. Where consulting services are performed under a fixed-price arrangement, revenues are generally recognized on a
percentage-of-completion basis. Maintenance services include both updates and technical support. Maintenance revenues are recognized ratably over the term of the maintenance
agreement, and generally range between 15% and 25% of the cumulative license fees and activation royalties incurred under the contract, depending upon the level of support being provided. Where
software license agreements include a combination of consulting, maintenance, and other services, these separate elements are unbundled from the arrangement based on each element's relative fair
value.

Deferred Revenues

Deferred revenues consist primarily of payments received from customers for prepaid license and royalty fees and prepaid services for undelivered products and
services. The timing of the conversion of these deferred revenue balances into income largely depends on when customers choose to deploy products and when services are performed for the customer.
Because of this, it is difficult to accurately predict when these deferred revenues will be converted into income. Although the Company has classified all of the deferred revenue balances as current
liabilities, a significant portion may be deferred or may not be recognized until subsequent fiscal years.

Comprehensive Income

Comprehensive income includes foreign currency translation gains and losses and unrealized gains and losses on marketable securities that have been previously
excluded from net income and reflected instead in equity. The Company has reported the components of comprehensive income on its statement of operations.

Computation of Net Loss Per Share

Basic net loss per share is computed using the weighted average number of shares of common stock outstanding. Potential common shares from the conversion of
preferred stock, stock options, and warrants are excluded from the calculation of diluted loss per share because including them would be anti-dilutive. As of May 31, 2000 and 2001,
approximately 15,401,376 and 15,119,958 potential shares were not included in the calculation as they would have been anti-dilutive.

Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting For Derivative Instruments And Hedging
Activities." SFAS No. 133 establishes accounting and reporting standards for derivative financial instruments and hedging activities related to those instruments, as well as other hedging
activities. The Company will adopt SFAS No. 133 effective June 1, 2001. Liberate does not expect that the adoption of SFAS No. 133 will have a material impact on its financial
position, results of operations, or cash flows.

55

---

In March 2000, the FASB issued FIN No. 44, "Accounting For Certain Transactions Involving Stock CompensationAn Interpretation Of APB Opinion No. 25."
This interpretation provides guidance regarding the application of APB No. 25 to stock compensation involving employees. The adoption of FIN No. 44 was effective July 1, 2000, and
did not have a material impact on Liberate's financial position, results of operations, or cash flows.

In
July 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangibles." SFAS No. 141 requires all business
combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. Under SFAS No. 142, goodwill is no longer subject to amortization over its
estimated useful life. Prospectively, goodwill is subject to at least an annual assessment for impairment applying a fair-value-based test. Additionally, an acquired intangible
asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed,
rented, or exchanged, regardless of the acquirer's intent to do so. As of May 31, 2001, the Company had $432.2 million of purchased intangibles recorded on its balance sheet, net of
accumulated amortization. Of this balance, approximately $426.1 million related to goodwill, and the remainder was comprised of other purchased intangibles, including patents, trademarks,
existing technology, customer relationships, and assembled workforce. Upon adoption of SFAS No. 142 on June 1, 2002, Liberate will cease to amortize goodwill, thereby eliminating annual
goodwill amortization expense of approximately $217.7 million based on anticipated amortization expense for fiscal 2002. Total amortization expense for goodwill and purchased intangibles for
fiscal 2001 was $216.1 million, of which approximately $213.0 million related to goodwill.

In
August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 establishes financial accounting and reporting
obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement will be effective in fiscal 2004. Management has not yet
assessed the impact of adopting SFAS No. 143.

3.  SEGMENT REPORTING

Liberate operates solely in one segmentproviding software and services to network operators and a broad range of consumer devices, primarily cable
and satellite set-top boxes. As of May 31, 1999, 2000, and 2001, the Company's long-term assets are located primarily in the United States. The Company's revenues by
region are as follows (in thousands):

Years Ended May 31,1999

2000

2001Europe

$
3,212

$
8,296

$
26,604North America


9,129


14,709


19,810Asia


4,972


5,012


5,295Consolidated

$
17,313

$
28,017

$
51,709


International
revenues consist of sales to customers outside of the United States. Revenues are assigned to specific countries based on the origin of the sales contract. For fiscal
1999, 2000, and 2001, North America revenues included United-States-based revenues of $8.5 million, $13.2 million, and $16.6 million, respectively. In addition, for fiscal 1999,
2000, and 2001, Europe revenues included

56

---

United-Kingdom-based revenues of $2.5 million, $7.1 million, and $21.2 million, respectively. During the years ended May 31, 1999, 2000, and 2001, international revenues
were 51%, 53%, and 68% of total revenues, respectively.

The
percentage of sales to significant customers was as follows:

Years Ended May 31,1999

2000

2001Customer A

15
%
21
%
21
%Customer B

*

*

19
%Customer C

23
%
15
%
*




4.  ACQUISITIONS

Navio

Effective August 11, 1997, the Company acquired Navio. In connection with the acquisition, the Company issued 17,441,322 shares of Series B and C
convertible preferred stock and stock options to acquire 6,315,780 shares of Series C convertible preferred stock in exchange for all of the outstanding
common stock, preferred stock, and options to purchase shares of Navio common stock. The acquisition was accounted for as a purchase and, accordingly, the results of operations of Navio have been
included in the consolidated financial statements commencing on the date of acquisition. The fair market value of the equity securities issued in the acquisition was $77.1 million and the total
purchase price was $77.7 million.

In
connection with the acquisition, for up to 60 days after the closing date, certain former common stockholders of Navio had the right to put to Oracle up to 50% of the
preferred shares they received, and shares issuable under stock options assumed by the Company in the acquisition, for a price of $3.35 per share. A total of 3,818,496 shares of Series C
convertible preferred stock for $12.8 million in proceeds were put to Oracle under this arrangement.

Oracle
held a call option to purchase all of the Series B and Series C convertible preferred stock at a to-be-determined buy-out
price, determined as follows: (1) if exercised prior to December 31, 1999, the price would be 120% of the per share price determined by an independent third-party valuation of the
Company's shares, or (2) if exercised after December 31, 1999, the per share price determined by an independent third-party valuation of the Company's shares. The call option terminated
upon the Company's IPO.

SourceSuite LLC

In March 2000, the Company acquired the VirtualModem assets of SourceSuite in exchange for 1,772,000 shares of the Company's common stock. The
acquisition was accounted for as a purchase and, accordingly, the results of operations of SourceSuite have been included in the consolidated financial statements commencing on the date of
acquisition. The fair market value of the equity securities issued in the acquisition was $190.5 million and the total purchase price was $194.3 million.

57

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The Company wrote off $1.9 million of acquired in-process research and development that, based on a third-party appraisal, had not reached technological feasibility
and had no alternative future use.
Purchased intangibles of $192.0 million were recorded and are being amortized on a straight-line basis over an estimated useful life of three years. Purchased intangibles are
comprised of approximately $6.5 million in existing technology, trademarks, and assembled workforce. The remaining balance is comprised of goodwill, which represents the purchase price in
excess of identified tangible and intangible assets. Amortization expense related to this transaction was $16.0 million for fiscal 2000 and $64.0 million for fiscal 2001. Accumulated
amortization was $80.0 million as of May 31, 2001.

The
value assigned to acquired in-process research and development was determined by identifying research projects in areas for which technological feasibility has not
been established. The value was determined by estimating the costs to develop the acquired in-process technology into commercially viable products, estimating the resulting net cash flows
from such projects, and discounting the net cash flows back to their present values. The discount rate includes a factor that takes into account the uncertainty surrounding the successful development
of the acquired in-process technology. If these projects are not successfully developed, future revenue and profitability of the Company may be adversely affected. Additionally, the value
of the other purchased intangible assets may be impaired.

In
connection with the acquisition, net assets acquired were as follows (in thousands):

Goodwill

$
185,493Other purchased intangibles, including in-process technology


8,400Property, plant and equipment and other non-current assets


421Receivables and other current assets


167Current liabilities assumed


(149
)Net assets acquired

$
194,332


The
following table presents (in thousands, except per share data) the unaudited pro forma results assuming that the Company had merged with SourceSuite at the beginning of fiscal
1999. Net income has been adjusted to exclude the write-off of acquired in-process research and development of $1.9 million and includes amortization of purchased
intangibles of $64.0 million for each of the years ended May 31, 1999 and 2000. This information may not necessarily indicate the future combined results of operations of the Company.

Years Ended May 31,1999

2000Revenues

$
17,313

$
28,017Net loss

$
(101,944
)
$
(129,607
)Basic net loss per share

$
(43.27
)
$
(1.83
)


MoreCom

In June 2000, the Company acquired MoreCom. In connection with the acquisition, the Company issued 7,310,830 shares of common stock in exchange for all
of the outstanding stock of MoreCom and assumed all of MoreCom's stock options. The acquisition was accounted for as a purchase. The fair

58

---

market value of the equity securities issued in the acquisition was approximately $459.0 million, and the purchase price was $495.1 million.

The
Company wrote off $22.4 million of acquired in-process research and development that, based on a third-party appraisal, had not reached technological
feasibility and had no alternative future use. Purchased intangibles of $470.9 million were recorded and are being amortized on a straight-line basis over an estimated useful life
of three years. Purchased intangibles are comprised of approximately $2.9 million of patents, customer relationships, and assembled workforce. The remaining balance is comprised of goodwill,
which represents the purchase price in excess of identified tangible and intangible assets. Amortization expense related to this transaction was $150.6 million for fiscal 2001.

The
value of MoreCom's in-process research and development was determined primarily on the basis of the income approach. Under this approach, the fair value of the
in-process research and development reflects the present value of the projected free cash flows that will be generated by the in-process research and development projects and
that is attributable to the acquired technology, if successfully completed. The income approach focuses on the income producing capability of the acquired technology, and best represents the present
value of the future economic benefits expected to be derived from them, and therefore, the fair value of the acquired technology. The projected revenues used in the income approach are based upon the
revenues likely to be generated upon the completion of the projects and the beginning of commercial sales, as estimated by management. The projections assume that the products will be successful and
that the products' development and commercialization meet management's current time schedule. In arriving at the appropriate discount rates, the implied rate of the transaction and the weighted
average cost of capital were considered. The discount rate applicable to the in-process project reflects the risks inherent in each project. An overall after-tax discount rate
of 20% was applied to the project's cash flows. The required returns of other assets were deducted from the incremental cash flows generated by the projects shown in the in-process
research and development model to determine the incremental cash flows specifically attributable to the in-process research and development project.

The
value of MoreCom's patents was developed primarily on the basis of the replacement cost approach. Under this method, the fair value of an asset is equal to the cost to replace the
functionality of the asset. In the case of patents, the replacement cost of the asset is equal to the royalty that would have to be paid for the right to use the patents if they were not acquired by
the Company. Because the Company acquired the patents, they were relieved from making royalty payments. As such, a relief-from-royalty method was used to apply the replacement
cost approach. To apply the relief-from-royalty method, an appropriate royalty rate was determined and applied to the expected sales of products associated with the patents.

The
customer relationships and assembled workforce were valued using the cost approach. Under this approach, the value is calculated based on the costs the Company avoided through
obtaining the relationships and workforce from the acquired party rather than incurring the costs to assemble them independently. Therefore, the fair value of the acquired customer relationships was
calculated as the costs which the Company avoided spending in recreating similar functional customer relationships. Similarly, the assembled workforce was valued by calculating the costs Liberate
avoided by obtaining a pre-existing, trained, and fully efficient team rather than incurring the costs to assemble this workforce.

59

---

In connection with the acquisition, net assets acquired were as follows (in thousands):

Goodwill

$
467,970Other purchased intangibles, including in-process technology


25,324Property, plant and equipment and other non-current assets


842Cash, receivables and other current assets


1,500Current liabilities assumed


(550
)Net assets acquired

$
495,086


The
following table presents (in thousands, except per share data) the unaudited pro forma results assuming that the Company had merged with MoreCom at the beginning of fiscal 2000.
Net income has been adjusted to exclude the write-off of acquired in-process research and development of $22.4 million and includes amortization of purchased intangibles
of $157.2 million for each of the years ended May 31, 2000 and May 31, 2001. This information does not necessarily indicate future combined results of operations.

Years Ended May 31,2000

2001Revenues

$
28,017

$
51,709Net loss

$
(243,080
)
$
(316,569
)Basic net loss per share

$
(3.42
)
$
(3.09
)


5.  PROPERTY AND EQUIPMENT

As of May 31, 2000 and 2001, property and equipment consisted of the following (in thousands):

As of May 31,2000

2001Computer equipment

$
6,216

$
11,961Leasehold improvements


6,074


8,131Furniture and equipment


3,526


5,190Software


1,446


3,51617,262


28,798Less: Accumulated depreciation and amortization


(4,503
)

(9,713
)$
12,759

$
19,085


60

---

6.  COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company has various operating leases that expire at various dates through fiscal 2010. Future minimum lease payments relating to these agreements as of
May 31, 2001, are as follows (in thousands):

Year ending May 31,2002

$
6,7292003


6,7842004


6,7062005


6,7752006


6,971Thereafter


27,008$
60,973


Rent
expense, without the effect of sublease income, under the Company's operating leases for the years ended May 31, 1999, 2000, and 2001 was $2.3 million,
$4.7 million, and $7.9 million, respectively. As of May 31, 2001, the Company had commitments by various sub-tenants of $774,000 that will be used to offset rent
expense in future periods. The related sublease agreements expire on various dates through October 2001. Payments received from the sub-tenants of $1.1 million for fiscal
2000 and $4.9 million in 2001, have been offset against rent expense in the consolidated statements of operations to the extent that an equal amount of expense was recognized. The excess rent
income, if any, was recorded in other income and expense. In May 2001, the Company entered into a settlement and mutual release agreement with one of its sub-tenants to accelerate
the expiration of the sub-tenant's sublease from
September 2002 to October 2001 in exchange for prepaid rent of $600,000 from the sub-tenant that will be applied over the remaining lease term.

In
September 1999, the Company entered into a facilities lease agreement. As part of the agreement, the Company is required to hold a certificate of deposit to secure an
Irrevocable Letter of Credit for its security deposit. As of May 31, 2001, the certificate of deposit amounted to $8.8 million and is included in restricted cash in the accompanying
consolidated balance sheet.

Capital Lease

In August 1999, the Company entered into a Master Equipment Lease to finance office furniture and equipment. In October 2000, the Company
purchased equipment valued at $100,000 under this master lease, bringing the total assets acquired under this lease to $2.0 million. As of May 31, 2001, accumulated depreciation for
these assets was $956,000.

61

---

The following is a schedule by years of future minimum lease payments under capital leases together with the present value of the future minimum lease payments as of May 31,
2001 (in thousands):

Year ending May 31,2002

$
7862003


3672004


10Total minimum lease payments


1,163Less: Amount representing interest


(102
)Present value of future minimum lease payments


1,061Less: Current portion


(672
)Long-term portion

$
389


Motorola

In April 1999, the Company entered into a Manufacturer's Representative Agreement and a Development Agreement with Motorola (which acquired General
Instrument in January, 2000). Under the Development Agreement, the Company committed to pay Motorola $10.0 million in development fees for certain services to be performed by Motorola. These
fees are being paid out over a three-year period. The Company expensed $3.6 million for each of fiscal 2000 and 2001. Under the Manufacturer's Representative Agreement, the Company
agreed to pay to Motorola a "commission" on all Motorola terminals deployed by network operators with the Company's products on them. However, the commissions become effective only after specific
sales thresholds are met. In connection with this commission, Motorola has committed to the Company that certain volumes of Motorola devices will be sold. After the three-year period is
over, Motorola may be required to pay the Company for any shortfall of terminal sales below committed volume levels.

Sun Microsystems

In May 1999, the Company entered into a Technology License and Distribution Agreement (the "Agreement") with Sun Microsystems ("Sun") to transfer its NC
Navigator and NC Administration Server software to Sun, while retaining the right to ship, support, and maintain these products for existing customers using this technology. During fiscal 2000, the
Company and Sun amended the Agreement. The amendment called for the Company to pay certain minimum royalties and support fees in exchange for the right to certain Sun technology and to maintain the
status as a preferred vendor of Sun. Minimum guaranteed royalties and support fees of approximately $3.8 million were to be paid to Sun through the period ended December 31, 2004. During
fiscal 2001, the Company further amended its Technology License and Distribution Agreement with Sun Microsystems. The new agreement eliminated the guaranteed royalties and support fees of
$3.8 million. In exchange for the elimination of the guarantees, the Company prepaid $1.4 million in royalties and support to Sun Microsystems. Royalty and support expenses under these
agreements were $250,000 for fiscal 1999, $583,000 for fiscal 2000, and $623,000 for fiscal 2001.

62

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Other Commitments

As of May 31, 2001, the Company had commitments, under a binding Letter of Understanding, for up to $5.0 million related to potential future
marketing activities. These amounts will be expensed when and if incurred.

Legal Matters

Beginning May 16, 2001, seven class-action lawsuits seeking monetary damages were filed in the Southern District of New York against several of the
firms that underwrote Liberate's IPO, naming Liberate, its CEO Mitchell Kertzman, and its CFO Nancy Hilker as co-defendants ("the Liberate defendants"). The plaintiffs allege that the
underwriters received excessive and improper commissions that were not disclosed in Liberate's prospectus. The Company believes that these cases are likely to be consolidated. A large number of
companies have been named in similar suits relating to allegedly improper underwriting practices. The Company will be seeking to have the claims against the Liberate defendants dismissed, and, while
litigation is by its nature uncertain, the Company does not believe that the cases create any material exposure for Liberate.

As
part of Liberate's acquisition of the VirtualModem software products and related assets and technology of SourceSuite described in Note 4, the Company acquired certain
patents that were the subject of a patent infringement lawsuit. This lawsuit was initially brought by Interactive Channel Technologies and SMI Holdings, affiliated companies of SourceSuite, against
Worldgate Communications in May 1998 in the U.S. District Court for the State of Delaware. The patent infringement claims have been assigned to Liberate as a result of its merger with
SourceSuite. In June 1998, Worldgate filed a counterclaim against the plaintiffs and Source Media, a shareholder of SourceSuite, alleging among others, violations of the Lanham Act and
Delaware's Uniform Deceptive Trade Practices Act, common law unfair competition, tortious interference with existing and prospective business relationships and misappropriation of confidential
information and trade secrets. Following discovery and briefing of the patent claim construction issues, the parties have entered into settlement negotiations covering both Liberate's patent
infringement claims against Worldgate and Worldgate's cross-complaint against Interactive Channel, SMI Holdings, and Source Media. On March 26, 2001, the U.S. District Court for the State of
Delaware ruled that the parties have entered into a settlement agreement under which each side dismissed its claims against the other.

7.  CONVERTIBLE PREFERRED STOCK

Since inception, Liberate has issued 66,189,208 shares of preferred stock. All outstanding shares of preferred stock were converted into shares of common stock
in connection with the Company's IPO in July 1999. Additionally, all outstanding warrants to purchase preferred stock were converted to warrants to purchase common stock. Upon closing of the
IPO, Liberate authorized 20,000,000 shares of undesignated preferred stock for future issuance. As of May 31, 2000 and 2001, there were no shares of preferred stock outstanding.

63

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8.  COMMON STOCK

The Company has authorized 200,000,000 shares of common stock. As of May 31, 2001, the Company has reserved the following shares of authorized, but
unissued shares of common stock for future issuance:

Employee stock purchase plan

2,777,582Warrants

3,883,328Stock options

17,080,70723,741,617


Warrant Agreements

In fiscal 1999, Liberate entered into letter agreements with several network operators whereby the Company agreed to issue warrants to purchase up to 4,599,992
shares of the Company's common stock, that can be earned and exercised if those network operators satisfy certain milestones within specific time frames. As of May 31, 2001, 552,774 warrants
had been exercised, 163,890 warrants had expired before they were earned, and 3,883,328 warrants remain available for future issue. The value of the warrants is estimated using the Black-Scholes
pricing model as of the earlier of the grant date or the date that it becomes probable that the warrants will be earned. Pursuant to the requirements of Emerging Issues Task Force
No. 96-18, the warrants will continue to be revalued in situations where they are granted prior to the establishment of a performance commitment. The value of the warrants was
recorded primarily as a non-current asset on the accompanying consolidated balance sheets and is being amortized over the estimated economic life of the arrangements with the network
operators.

As
of May 31, 2001, these network operators had earned warrants to purchase up to 2,336,660 shares of the Company's common stock, of which warrants to purchase 552,774 shares
had been exercised and 1,783,886 shares remain outstanding. The value of these warrants at the time they were earned, based on the Black-Scholes pricing model, was $117.2 million. As of
May 31, 2001, accumulated amortization for the warrants was $34.0 million. If the remaining warrants are earned, Liberate may be required to record additional significant
non-cash accounting expenses.

Stock Splits

In May 1999, the Company's Board of Directors approved a one-for-six reverse stock split of the Company's outstanding shares of
common and preferred stock that was declared effective on July 26, 1999. All share and per share information included in the accompanying consolidated financial statements and notes have been
adjusted retroactively to reflect this reverse stock split.

In
December 1999, the Company announced a two-for-one stock split in the form of a stock dividend that was declared effective January 14, 2000.
At the effective date of the stock split, the number of shares of Liberate's common stock outstanding increased to approximately 83,600,000 shares. All share and per share information included in the
accompanying consolidated financial statements and notes have been adjusted retroactively to reflect this split.

Initial Public Offering

In July 1999, Liberate sold 12,500,000 shares of common stock at $8 per share in connection with its IPO. Liberate sold an additional 902,100 shares of
common stock at $8 per share related to the

64

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exercise of the underwriters' over-allotment. The total aggregate proceeds from these transactions were $107.2 million. Underwriters' discounts and other related costs were
$9.4 million, resulting in net proceeds of $97.8 million.

Private Placement with Lucent Technologies

In June 1999, the Company entered into a stock purchase agreement with Lucent Technologies under which, contingent upon and immediately following
consummation of the sale of shares in the IPO, Lucent agreed to invest $12.5 million in a private placement of shares of the Company's common stock at a price per share equal to 96% of the IPO
price.

Secondary Offering

In February 2000, Liberate completed a secondary public offering in which it sold 2,890,000 shares of common stock at $108 per share. Proceeds from this
transaction were $312.1 million. Underwriters' discounts and other related costs were $14.9 million, resulting in net proceeds of $297.2 million.

Private Placement with Cisco Systems

In July 2000, the Company issued 3,963,780 unregistered shares of common stock to Cisco Systems, resulting in cash proceeds of $100.0 million.

9.  STOCK PLANS

1996 Stock Option Plan

In October 1996, the Company adopted the 1996 Stock Option Plan (the "1996 Plan"). The 1996 Plan, as amended, provides for the grant of both incentive
and non-qualified stock options to employees, consultants, and directors for the purchase of up to 11,666,666 shares of Series A common stock. Incentive stock options may be granted
only to employees.

The
exercise price of incentive stock options cannot be less than the fair market value of the common stock on the grant date, as determined by the Board of Directors. The exercise
price of non-qualified options may not be less than 85% of the fair market value on the grant date. The term of the incentive and non-qualified stock options is generally ten
years from the date of grant or a shorter term as provided in the option agreement. Options generally vest over three to four years.

1999 Equity Incentive Plan

In May 1999, the Board of Directors adopted, and the stockholders approved, the Company's 1999 Equity Incentive Plan (the "1999 Plan"). The types of
awards that may be made under the 1999 Plan are options to purchase shares of common stock, stock appreciation rights, restricted shares, and stock units. Any shares not yet issued under the 1996 Plan
as of the date of the Company's IPO were available for grant under the 1999 Plan, or 3,051,498 shares, plus, commencing on June 1, 2000, annual
increases equal to the lesser of 6,000,000 shares or 5% of the outstanding common shares on such date. The exercise price for all incentive stock options and nonstatutory stock options may not be less
than 100% or 85%, respectively, of the fair market value of the Company's common stock on the date of grant. The options generally vest over three to four years and have a term of ten years.

65

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Stock option activity under the 1996 Plan and the 1999 Plan is summarized below:

Options
Available For
Grant

Options
Outstanding

Weighted
Average
Exercise
PriceBalance at May 31, 1998

1,711,966

2,861,410

$
1.40Authorized

6,666,666




Granted

(4,303,458
)
4,303,458

$
3.21Exercised



(356,300
)
$
1.08Cancelled

655,612

(655,612
)
$
1.70Balance at May 31, 1999

4,730,786

6,152,956

$
2.65Granted

(4,043,785
)
4,043,785

$
37.76Exercised



(1,226,194
)
$
1.95Cancelled1996 Plan

60,752

(738,108
)
$
3.29Cancelled1999 Plan

12,000

(12,000
)
$
77.29Balance at May 31, 2000

759,753

8,220,439

$
19.86Authorized

4,546,386




Granted

(4,928,318
)
4,928,318

$
20.06Exercised



(951,961
)
$
3.01Cancelled1996 Plan



(685,934
)
$
3.81Cancelled1999 Plan

3,202,922

(3,202,922
)
$
46.40Balance at May 31, 2001

3,580,743

8,307,940

$
12.98


Additionally,
on October 15, 1998, the Company issued non-qualified stock options outside of the Plan to an executive officer and to an outside director for the
purchase of 4,999,998 shares of the Company's common stock at a price of $2.55 per share. During the years ended May 31, 1999, 2000, and 2001, options to purchase 451,388 shares, 326,387
shares, and 530,000 shares were exercised. As of May 31, 2001, options to purchase 3,692,223 shares were still outstanding, of which 2,129,723 shares were vested. The options vest over four
years and have a term of ten years.

Navio Stock Option Plan

In connection with the Company's acquisition of Navio, each outstanding option to purchase shares of Navio common stock was automatically converted into an
option to purchase convertible preferred stock of the Company based upon the conversion ratio.

Options
assumed are immediately exercisable and the shares of stock issued upon exercise that are unvested are subject to repurchase, at the original purchase price, by the Company
upon the termination of the optionholders' service. The Company's repurchase right generally expires at the rate of 25% of the original grant 12 months after the date of grant or employment and
75% in equal monthly increments over the following 36 months. During the years ended May 31, 2000 and 2001, the Company exercised its right to repurchase 6,218 and 17,345 shares,
respectively.

As
of May 31, 2001, the Navio plan had 488,604 options outstanding at a weighted average exercise price of $0.64 per share, of which 452,562 options were vested. Also as of
May 31, 2001, an

66

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additional 966 vested options were outstanding, specifically for Navio vendors, at a weighted average exercise price of $0.18 per share. The Navio plan was terminated upon assumption by the Company
and no further options have been granted under the Navio plan. During the years ended May 31, 1999, 2000, and 2001, Navio options to purchase 1,518,010 shares, 1,095,101 shares, and 339,461
shares were exercised. Also during the years ended May 31, 1999, 2000 and 2001, Navio vendor options to purchase 40,528 shares, 49,756 shares, and 3,576 shares were exercised.

MoreCom Stock Option Plans

In connection with the acquisition of MoreCom, the Company assumed MoreCom's 1998 Stock Option Plan and the 2000 Equity Incentive Plan ("MoreCom Plans").
Options granted under the MoreCom Plans generally have a term of ten years and vest over a four-year period. Options to purchase a total of 1,169,180 shares of the Company's common stock
were assumed in connection with the acquisition of MoreCom, of which options to purchase 93,032 shares were exercised during the year ended May 31, 2001. As of May 31, 2001, the MoreCom
Plan had 1,010,229 options outstanding at a weighted average exercise price of $11.79 per share, of which 466,963 options were vested. The MoreCom Plans were terminated upon assumption by the Company
and no further options will be granted under them.

Stock Option Exchange Program

On March 23, 2001, the Company announced a voluntary stock option exchange program for its employees. Under the program, employees had the opportunity
to cancel outstanding stock options previously granted to them under the Liberate Technologies 1999 Equity Incentive Plan in exchange for an equal number of new options to be granted at a future date,
at least six months and a day from the cancellation date, which was May 4, 2001. A total of 2,383,898 options were cancelled in connection with the option exchange. The exercise price of the
new options will be equal to the fair market value of the Company's common stock at the date of the new grant. Members of the Company's Board of Directors and executive officers were not eligible to
participate in the program.

Stock-Based Compensation

The Company accounts for outstanding stock options under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB
No. 25"), as allowed by SFAS No. 123. In accordance with APB No. 25, no compensation expense has been recognized related to options granted to employees except as discussed below
in "Deferred Stock Compensation," as all employee options were granted with an exercise price equal to the fair market value of the underlying stock. If
compensation cost had been determined consistent with SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's pro forma net loss would have been as follows (in thousands):

Years Ended May 31,1999

2000

2001Net lossas reported

$
(33,053
)
$
(80,771
)
$
(306,438
)Net losspro forma

$
(36,446
)
$
(112,632
)
$
(357,018
)


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Pursuant
to the provisions of SFAS No. 123, the fair value of options granted and ESPP shares issued was estimated on the grant date using the Black-Scholes option pricing
model and the following weighted average assumptions:

Options

ESPPYear ended May 31,

Year ended May 31,1999

2000

2001

2000

2001Risk-free interest rate


4.75%


6.09%


6.03%


6.18%


5.00%Average expected life of options granted and ESPP shares issued


3.97 years


4.62 years


6.00 years


0.67 years


0.50 yearsDividend yield


0%


0%


0%


0%


0%Volatility of common stock


70%


146%


125%


144%


116%Weighted average fair value of options granted and ESPP shares issued

$
4.32

$
35.36

$
17.84

$
6.10

$
11.26


A
summary of all outstanding options, including those assumed in connection with the Navio and MoreCom acquisitions and the stock options issued outside of the Plans, to purchase
common stock as of May 31, 2001 is as follows:

|  |       |  |   | Options Outstanding |  |            |  |     
|- | ----- |  | - | ------------------- |  | ---------- |  | ----
|
|
|
|$ | 0.18  |  | $ | 2.85                |  | 6,085,170  |  | 7.09
|$ | 3.07  |  | $ | 4.80                |  | 2,494,112  |  | 7.96
|$ | 5.34  |  | $ | 23.00               |  | 2,227,091  |  | 9.09
|$ | 23.06 |  | $ | 32.44               |  | 2,530,917  |  | 8.92
|$ | 33.00 |  | $ | 122.80              |  | 162,672    |  | 8.74
|  |       |  |   |                     |  |            |  |     
|  |       |  |   |                     |  | 13,499,962 |  | 7.94
|  |       |  |   |                     |  |            |  |     

Deferred Stock Compensation

In connection with the grant of certain stock options to employees in fiscal 1999 and 2000, the Company recorded deferred compensation of $7.1 million
and $1.6 million, respectively, representing the difference between the estimated fair value of the common stock for accounting purposes and the option exercise price of such options at the
date of grant. Such amount is presented as a reduction of stockholders' equity. Liberate expensed $507,000, $2.1 million, and $1.9 million for fiscal 1999, 2000, and 2001, respectively,
and will expense the balance ratably over the period the options vest (generally four years). Compensation expense is decreased in the period of forfeiture for any accrued but unvested compensation
arising from the early termination of an optionholder's services.

68

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Amortization of deferred stock compensation is shown as a separate line item in the accompanying consolidated statements of operations. Amortization of deferred stock compensation
includes amounts related to the following categories (in thousands):

Years ended May 31,1999

2000

2001Cost of service revenues

$
118

$
251

$
248Research and development


208


1,023


930Sales and marketing


119


457


426General and administrative


62


322


280$
507

$
2,053

$
1,884


1999 Employee Stock Purchase Plan

In May 1999, the Board of Directors adopted, and the stockholders approved, the Company's 1999 Employee Stock Purchase Plan (the "1999 Purchase Plan").
A total of 1,666,666 shares of common stock were reserved for issuance under the 1999 Purchase Plan, plus, commencing on June 1, 2000, annual increases equal to the lesser of 1,666,666 shares,
2% of the outstanding common shares on such date, or a lesser amount determined by the Board of Directors. The 1999 Purchase Plan permits eligible employees to acquire shares of the Company's common
stock through periodic payroll deductions of up to 15% of base cash compensation. Each participant may purchase up to 1,500 shares on any purchase date. Each offering period will have a maximum
duration of 6 months. However, the first offering period commenced on the effective date of the IPO and ended on March 31, 2000. The price at which the common stock may be purchased is
85% of the lower of the fair market value of the Company's common stock on the date immediately before the first day of the applicable offering period or on the last day of the respective purchase
period. As of May 31, 2001, 3,333,332 shares of common stock had been reserved under the Plan, of which 2,777,582 shares remained available for issuance. Employees purchased 289,234 and 266,516
shares in fiscal 2000 and 2001, respectively.

10.  INCOME TAXES

The Company entered into a tax sharing agreement with Oracle that was effective August 12, 1997. Under the terms of the agreement, the Company is
responsible for its share of Oracle's consolidated tax liability, computed as if the Company had filed a separate return. Further, if the Company would otherwise have had no tax due on a separate
return basis and the inclusion of the Company's tax operating losses reduced Oracle's consolidated tax liability, Oracle would pay to the Company the tax savings generated by including the Company in
its consolidated tax return. Subsequent to the acquisition of Navio on August 12, 1997, the Company is no longer included in Oracle's consolidated Federal Tax Returns. For the year ended
May 31, 1999, Oracle realized state and local tax savings of approximately $781,000. This amount is reflected as a benefit in the accompanying statement of operations. After the Company's IPO,
the Company is no longer included in Oracle's combined state filings.

69

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Income taxes have been calculated on a separate company basis pursuant to the provisions of SFAS No. 109, "Accounting for Income Taxes." The components of the provision
(benefit) for income taxes are as follows (in thousands):

Years Ended May 31,1999

2000

2001Current:Federal

$


$


$
State


(781
)




72Foreign


195


137


443Total provision (benefit)

$
(586
)
$
137

$
515


The
provision (benefit) for income taxes differs from the amounts that would result by applying the applicable statutory Federal income tax rate to income before taxes as follows (in
thousands):

Years Ended May 31,1999

2000

2001Benefit at Federal statutory rate

$
(11,774
)
$
(28,222
)
$
(107,073
)State income taxes, net of Federal benefit


(1,917
)

(4,596
)

(17,438
)Change in valuation allowance


10,926


22,537


31,691Tax credits





(580
)

(4,269
)Non-deductible write-off of in-process research and development





788


9,127Non-deductible goodwill amortization


2,129


8,987


87,963Stock compensation





835


767Other


50


388


(253
)Total provision (benefit)

$
(586
)
$
137

$
515


Components
of the net deferred tax asset are as follows (in thousands):

Years Ended May 31,2000

2001Net operating losses

$
7,788

$
86,716Temporary differences


34,676


41,983Tax credits


2,491


10,587Total deferred tax asset


44,955


139,286Valuation allowance


(44,955
)

(139,286
)Total net deferred tax asset

$


$



A
valuation allowance has been recorded for the entire deferred tax asset as a result of uncertainties regarding realization of the asset including limited operating history of the
Company, the lack of profitability to date and the uncertainty over future operating profitability. As of May 31, 2001,

70

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approximately $62.6 million of the valuation allowance relates to benefits of stock option deductions, which, if recognized, will be allocated directly to stockholders' equity.

As
of May 31, 2001, the Company had federal and state net operating loss carryforwards of $247.8 million and $67.1 million, respectively, and tax credits totaling
$10.6 million. The federal and state net operating loss carryforwards expire at various dates between 2005 and 2021. The tax credits expire at various dates between 2011 and 2021. Under current
tax law, net operating loss carryforwards available to offset future operating income in any given year may be limited upon the occurrence of certain events, including significant changes in ownership
interests.

11.  RELATED PARTY TRANSACTIONS

Transactions with Oracle

In December 1995, the Company began operations as a division of Oracle. As of May 31, 2001, Oracle owned 32% of the outstanding common stock of
the Company.

In
August 1997, in connection with the acquisition of Navio, the Company entered into a put/call and voting agreement with Oracle and former Navio stockholders, including
Netscape. Among other things, this agreement granted the former Navio stockholders the right, for a period of 60 days following the closing of the acquisition, to compel Oracle to purchase up
to 50% of the shares received by them in the acquisition or 50% of the shares issuable under stock options assumed by the Company in the acquisition. As a result of the exercise of these put rights,
Oracle purchased a total of 3,818,496 shares of the Company's Series C preferred stock. Oracle subsequently converted these shares into shares of the Series C-1 preferred
stock. The shares of preferred stock converted into an equal number of shares of common stock upon the closing of the Company's IPO.

The
Company previously leased office space in Redwood Shores, California from Oracle under a lease that provided for monthly payments of $124,000. The Company terminated the lease in
September 1999. The Company also previously leased furniture and equipment for the Redwood Shores office from Oracle under a lease entered into in September 1997, as amended, that
obligated the Company to make monthly payments to Oracle of $57,000. In addition, the Company previously contracted for Oracle to perform maintenance and repair services at the Redwood Shores office.
The furniture and equipment lease and the maintenance and repair services agreement were terminated simultaneously with the office lease.

The
Company previously leased office space in Salt Lake City, Utah from Oracle under a lease that provided for monthly payments of $4,000. The lease terminated in
February 2000. The Company also leased furniture and equipment for the Salt Lake City office from Oracle under a furniture lease signed with Oracle in March 1999 that provided for
monthly payments of $750.

The
Company previously leased office space in London, England from Oracle under a lease that provided for monthly payments of $4,200. The lease terminated in October 2000,
however, the Company continued to lease this space on a month-to-month basis through December 2000.

During
the fourth quarter of fiscal 1999, the Company entered into a lease for the office space in San Carlos, California. In connection with entering into this lease, Oracle provided
a $10.0 million guaranty to the landlord. The guaranty was terminated after the closing of the Company's IPO in July 1999.

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The Company entered into a Technical Support Services Agreement dated August 12, 1998 with Oracle. The Technical Support Services Agreement describes the terms under which
Oracle may provide technical support services for Oracle products when licensed by the Company or its distributors and the Company's products licensed by the Company, Oracle, or either of their
distributors.

The
Company entered into a Technology License Agreement with Oracle in September 1998. Pursuant to the Technology License Agreement, Oracle may promote, market and distribute
sublicenses of the Company's products through its worldwide distribution channels for a period of three years.

During
fiscal 1999 and fiscal 2000, the Company paid $243,000 and $107,000, respectively, to Oracle Japan for commissions related to the license of software. There were no payments
made in fiscal 2001 for commissions. Oracle paid Liberate royalties of $371,000 in fiscal 1999, $147,000 in fiscal 2000, and $239,000 in fiscal 2001.

For
each of the fiscal years 1999 and 2000, revenues from related parties of $156,000 and $293,000, respectively, represented 1% of the Company's total revenues. For fiscal 2001,
revenues from related parties of $197,000 represented less than 1% of the Company's total revenues.

Transactions with Officers

In January 2001, Liberate extended loans in exchange for promissory notes from Coleman Sisson, the Company's President and Chief Operating Officer, and
David Limp, the Company's Executive Vice President and Chief Strategy Officer. In April 2001, Liberate extended a loan in exchange for a promissory note from Donald Fitzpatrick, The Company's
Executive Vice President, Sales and Service. Each loan is in the amount of $500,000 at 5.9% compounded annually and is due and payable two years from issuance.

In
January 2001, the Company also entered into employee retention agreements with Mr. Sisson, Mr. Fitzpatrick, and Mr. Limp. Each retention agreement
provides approximately $820,000 to the employee over the next two years of continued service.

12.  THIRD-PARTY FINANCING AGREEMENTS

On November 12, 1997, the Company entered into a Convertible Promissory Note Purchase and Cooperation Agreement (the "Agreement") with a third-party
investor (the "Investor"). The Agreement was for the sale of up to three $4.0 million Convertible Promissory Notes ("the Notes") that are convertible into Series D convertible preferred
stock. During the year ended May 31, 1998, the Company sold the first Note of $4.0 million. These Notes automatically converted on the consummation of the Company's IPO. As of
May 31, 2001, no further activity has occurred under this arrangement.

In
the Agreement, the investor agreed to fund $3.0 million of the Company's non-recurring engineering ("NRE") efforts through December 31, 1999. The Company
recognizes the NRE revenue as services are performed and recognized $871,000 of revenue for fiscal 1999, $1.3 million of revenue for fiscal 2000, and $703,000 of revenue for fiscal 2001. In
consideration of the funding, the Company agreed to pay the investor a royalty for each license of the Company's software incorporating that technology, up to a maximum of $3.9 million. The
obligation to pay the royalty terminates four years after the first commercial shipment of hardware implementing the Company's software.

72

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13.  RETIREMENT PLAN

The Company has a retirement plan under Section 401(k) of the Internal Revenue Code. Under the retirement plan, participating employees may defer a
portion of their pre-tax earnings up to the Internal Revenue Service annual contribution limit. The Company may make contributions to the plan at the discretion of the Board of Directors.
To date, the Company has not made any such contributions.

14.  SUBSEQUENT EVENTS

In June 2001, Liberate committed to invest $2.0 million in China Broadband (H.K.), for reinvestment in China New Broadband Video &
Communication, a Chinese joint venture that makes interactive television software. The investment will be made in five phases over the next year, based upon the achievement of specific technical and
commercial milestones. The first investment of $750,000 was made in June 2001.

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SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS (In thousands)

|                                 |                          | Balance at
Beginning of
Year |   | Deductions,
Additions
Returns and
Provisions |  | Write-Offs |     | Balance at
End of Year
|-------------------------------- | ------------------------ | ---------------------------- | - | -------------------------------------------- |  | ---------- | --- | ----------------------
|Allowance for doubtful accounts: |                          |                              |   |                                              |  |            |     |                       
|                                 | Year ending May 31, 2001 |                              | $ | 436                                          |  | $          | 145 |                       
|                                 | Year ending May 31, 2000 |                              |   | 247                                          |  |            | 226 |                       
|                                 | Year ending May 31, 1999 |                              |   | 278                                          |  |            | 220 |                       

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