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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-Q

|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                 
|þ          |  | QUARTERLY REPORT PURSUANT TO SECTION 13
    OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934 
|          
|           |  | For the quarter ended June 30,
    2002                                                         
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to                                                 

Commission file number 0-21126

SONICblue Incorporated

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                     
|------------------------------------------------------------------ |  | ------------------------------------
|Delaware                                                           |  | 77-0204341                          
|(State or other jurisdiction of incorporation
    or organization) |  | (I.R.S. Employer Identification No.)
|2841 Mission College Boulevard
    Santa Clara, California         |  | 95054                               
|(Address of principal executive
    offices)                       |  | (Zip Code)                          

Registrants telephone number, including
area code: (408) 588-8000

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

The number of shares of the Registrants
Common Stock, $0.0001 par value, outstanding at August 2,
2002 was 97,635,443.



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TABLE OF CONTENTS



|                           |                                                                                               |                                                                |  |  |  |  |  | 
|-------------------------- | --------------------------------------------------------------------------------------------- | -------------------------------------------------------------- |  |  |  |  |  | 
|                           | Item 1. Condensed Consolidated Financial Statements                                          
|                           |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS                         
|                           |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS               
|                           |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS                         
|                           |                                                                                               | NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                           | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                           | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|PART II. OTHER INFORMATION
|                           | Item 1. Legal Proceedings                                                                    
|                           | Item 2. Changes in Securities and Use of Proceeds                                            
|                           | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                           | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                



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##### Table of Contents



SONICblue INCORPORATED

FORM 10-Q

INDEX

|                                                          |  |                                                                                                                      |    |      |    | 
|--------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                                                          |  |                                                                                                                      |    | Page
|                                                          |  |                                                                                                                      |    |     
|PART I.  CONDENSED CONSOLIDATED
    FINANCIAL INFORMATION
|Item 1.                                                   |  | Condensed Consolidated Financial Statements:                                                                         |    |      | 2  | 
|                                                          |  | Condensed Consolidated Balance Sheets at June 30,
    2002 and December 31, 2001                                     |    |      | 2  | 
|                                                          |  | Condensed Consolidated Statements of Operations
    for the three months and six months ended June 30, 2002 and 2001 |    |      | 3  | 
|                                                          |  | Condensed Consolidated Statements of Cash Flows
    for the six months ended June 30, 2002 and 2001                  |    |      | 4  | 
|                                                          |  | Notes to Unaudited Condensed Consolidated
    Financial Statements                                                   |    |      | 5  | 
|Item 2.                                                   |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                            |    |      | 16 | 
|Item 3.                                                   |  | Quantitative and Qualitative Disclosures About
    Market Risk                                                       |    |      | 39 | 
|PART II.  OTHER
    INFORMATION                          
|Item 1.                                                   |  | Legal Proceedings                                                                                                    |    |      | 40 | 
|Item 2.                                                   |  | Changes in Securities and Use of Proceeds                                                                            |    |      | 43 | 
|Item 4.                                                   |  | Submission of Matters to a Vote of Security
    Holders                                                              |    |      | 43 | 
|Item 6.                                                   |  | Exhibits and Reports on Form 8-K                                                                                     |    |      | 44 | 
|Signatures                                                |  |                                                                                                                      | 45 |     

1



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##### Table of Contents



PART I.     CONDENSED
CONSOLIDATED FINANCIAL INFORMATION




Item 1.     Condensed
Consolidated Financial Statements

SONICblue INCORPORATED






CONDENSED CONSOLIDATED BALANCE
SHEETS


|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |          |         | 
|---------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | ------- | ------------ | ------- |  | ------- | -------- | ------- | 
|                                         |                                                                                                                                                                           | June 30,                  |         | December 31,
|                                         |                                                                                                                                                                           | 2002                      |         | 2001        
|                                         |                                                                                                                                                                           |                           |         |             
|                                         |                                                                                                                                                                           | (Unaudited)               |         |             
|                                         |                                                                                                                                                                           |                          
|                                         |                                                                                                                                                                           | (In thousands, except    
|                                         |                                                                                                                                                                           | per share data)          
|ASSETS                                  
|Current assets:                          |                                                                                                                                                                           |                           |         |              |         |  |         |         
|                                         | Cash and other investments                                                                                                                                                |                           | $       | 48,338       |         |  | $       | 22,081   |        
|                                         | Investment  UMC                                                                                                                                                          |                           |         | 64,757       |         |  |         | 75,907   |        
|                                         | Accounts receivable, net                                                                                                                                                  |                           |         | 35,416       |         |  |         | 30,986   |        
|                                         | Inventories                                                                                                                                                               |                           |         | 24,687       |         |  |         | 20,571   |        
|                                         | Prepaid expenses and other                                                                                                                                                |                           |         | 8,722        |         |  |         | 8,003    |        
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         
|                                         |                                                                                                                                                                           | Total current assets      |         |              | 181,920 |  |         |          | 157,548 | 
|Property and equipment, net              |                                                                                                                                                                           |                           | 6,248   |              |         |  | 7,218   |         
|Investment  UMC                         |                                                                                                                                                                           |                           | 57,924  |              |         |  | 86,886  |         
|Deferred income taxes                    |                                                                                                                                                                           |                           | 11,894  |              |         |  | 15,197  |         
|Goodwill and intangible assets           |                                                                                                                                                                           |                           | 122,600 |              |         |  | 128,426 |         
|Other assets                             |                                                                                                                                                                           |                           | 13,878  |              |         |  | 18,232  |         
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         
|                                         |                                                                                                                                                                           | Total                     |         | $            | 394,464 |  |         | $        | 413,507 | 
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                                           |                           |         |              |         |  |         |         
|                                         | Accounts payable                                                                                                                                                          |                           | $       | 35,830       |         |  | $       | 46,556   |        
|                                         | Line of credit                                                                                                                                                            |                           |         | 16,509       |         |  |         | 15,826   |        
|                                         | Accrued liabilities                                                                                                                                                       |                           |         | 88,165       |         |  |         | 116,304  |        
|                                         | Deferred income taxes                                                                                                                                                     |                           |         | 11,894       |         |  |         | 15,197   |        
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         
|                                         |                                                                                                                                                                           | Total current liabilities |         |              | 152,398 |  |         |          | 193,883 | 
|Other liabilities                        |                                                                                                                                                                           |                           | 29,785  |              |         |  | 22,764  |         
|Convertible subordinated notes           |                                                                                                                                                                           |                           | 144,461 |              |         |  | 103,300 |         
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         
|                                         |                                                                                                                                                                           | Total liabilities         |         |              | 326,644 |  |         |          | 319,947 | 
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         
|Stockholders equity:                    |                                                                                                                                                                           |                           |         |              |         |  |         |         
|                                         | Preferred stock, $0.0001 par value; 5,000,000
    shares authorized; none outstanding                                                                                     |                           |         |             |         |  |         |         |        
|                                         | Common stock, $0.0001 par value; 175,000,000
    shares authorized; 97,635,443 and 93,464,528 shares outstanding
    at June 30, 2002 and December 31, 2001, respectively |                           |         | 10           |         |  |         | 9        |        
|                                         | Additional paid-in capital                                                                                                                                                |                           |         | 610,217      |         |  |         | 583,922  |        
|                                         | Unearned stock based compensation                                                                                                                                         |                           |         | (2,264       | )       |  |         | (3,801   | )      
|                                         | Accumulated other comprehensive gain (loss)                                                                                                                               |                           |         | (12,556      | )       |  |         | 993      |        
|                                         | Retained earnings (accumulated deficit)                                                                                                                                   |                           |         | (527,587     | )       |  |         | (487,563 | )      
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         
|Stockholders equity                     |                                                                                                                                                                           |                           | 67,820  |              |         |  | 93,560  |         
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         
|                                         |                                                                                                                                                                           | Total                     |         | $            | 394,464 |  |         | $        | 413,507 | 
|                                         |                                                                                                                                                                           |                           |         |              |         |  |         |         

See accompanying notes to the unaudited condensed
consolidated financial statements.

2



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##### Table of Contents



SONICblue INCORPORATED






CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


|                                            |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |         |         | 
|------------------------------------------- | ------------------------------------------------------------------- | ------------------------------------- | ------- | ---------------- | ------ | -------- | -------- | -------- | ------- | - | ------- | ------ | ------ | - | -------- | ------- | ------- | 
|                                            |                                                                     |                                       |         |                 
|                                            |                                                                     | Three Months Ended                    |         | Six Months Ended
|                                            |                                                                     |                                       |         |                 
|                                            |                                                                     | June 30,                              |         | June 30,         |        | June 30, |          | June 30,
|                                            |                                                                     | 2002                                  |         | 2001             |        | 2002     |          | 2001    
|                                            |                                                                     |                                       |         |                  |        |          |          |         
|                                            |                                                                     |                                       |         |                 
|                                            |                                                                     | (Unaudited)                           |         | (Unaudited)     
|                                            |                                                                     |                                      
|                                            |                                                                     | (In thousands, except per share data)
|Net sales                                   |                                                                     | $                                     | 61,682  |                  |        | $        | 29,508   |          |         | $ | 126,749 |        |        | $ | 79,394   |        
|Cost of sales                               |                                                                     |                                       | 48,747  |                  |        |          | 97,019   |          |         |   | 101,978 |        |        |   | 163,674  |        
|                                            |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|Gross profit (loss)                         |                                                                     |                                       | 12,935  |                  |        |          | (67,511  | )        |         |   | 24,771  |        |        |   | (84,280  | )      
|                                           
|Operating expenses:                         |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|                                            | Research and development                                            |                                       |         | 4,080            |        |          |          | 6,446    |         |   |         | 8,405  |        |   |          | 17,121  |        
|                                            | Selling, marketing and administrative                               |                                       |         | 13,970           |        |          |          | 34,099   |         |   |         | 29,438 |        |   |          | 58,985  |        
|                                            | Restructuring, impairment and in-process R&D                        |                                       |         | 6,884            |        |          |          | 123,111  |         |   |         | 13,631 |        |   |          | 123,111 |        
|                                            | Amortization of goodwill, intangibles and
    deferred compensation |                                       |         | 3,989            |        |          |          | 11,164   |         |   |         | 8,100  |        |   |          | 22,288  |        
|                                            |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|                                            |                                                                     | Total operating expenses              |         |                  | 28,923 |          |          |          | 174,820 |   |         |        | 59,574 |   |          |         | 221,505 | 
|                                            |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|Loss from operations                        |                                                                     |                                       | (15,988 | )                |        |          | (242,331 | )        |         |   | (34,803 | )      |        |   | (305,785 | )      
|Gain (loss) on UMC investment               |                                                                     |                                       | 681     |                  |        |          | (69,919  | )        |         |   | 5,133   |        |        |   | (527,957 | )      
|Gain (loss) on other investments            |                                                                     |                                       | (2,904  | )                |        |          | (20,858  | )        |         |   | (3,664  | )      |        |   | (21,590  | )      
|Interest expense                            |                                                                     |                                       | (4,806  | )                |        |          | (3,022   | )        |         |   | (6,612  | )      |        |   | (6,148   | )      
|Other income (expense), net                 |                                                                     |                                       | (439    | )                |        |          | (1,077   | )        |         |   | (78     | )      |        |   | (1,064   | )      
|                                            |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|Income (loss) before income taxes           |                                                                     |                                       | (23,456 | )                |        |          | (337,207 | )        |         |   | (40,024 | )      |        |   | (862,544 | )      
|Income tax expense (benefit)                |                                                                     |                                       |        |                  |        |          | (24,666  | )        |         |   |        |        |        |   | (214,233 | )      
|                                            |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|Net income (loss)                           |                                                                     | $                                     | (23,456 | )                |        | $        | (312,541 | )        |         | $ | (40,024 | )      |        | $ | (648,311 | )      
|                                            |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|                                           
|Earnings (loss) per share amounts:          |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|                                            | Basic                                                               |                                       | $       | (0.24            | )      |          | $        | (3.88    | )       |   | $       | (0.42  | )      |   | $        | (7.50   | )      
|                                            | Diluted                                                             |                                       | $       | (0.24            | )      |          | $        | (3.88    | )       |   | $       | (0.42  | )      |   | $        | (7.50   | )      
|                                           
|Shares used in computing per share amounts: |                                                                     |                                       |         |                  |        |          |          |          |         |   |         |        |        |   |          |        
|                                            | Basic                                                               |                                       |         | 96,506           |        |          |          | 80,503   |         |   |         | 95,394 |        |   |          | 86,402  |        
|                                            | Diluted                                                             |                                       |         | 96,506           |        |          |          | 80,503   |         |   |         | 95,394 |        |   |          | 86,402  |        

See accompanying notes to the unaudited condensed
consolidated financial statements.

3



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##### Table of Contents



SONICblue INCORPORATED






CONSOLIDATED STATEMENTS OF CASH
FLOWS


|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |          |          |         |          |  
|-------------------------------------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------- | ----------------------------------------- | -------------------------------------------------------- | ------ | ------- | ------- | -------- | -------- | ------- | -------- | -
|                                                         |                                                                                               |                                   
|                                                         |                                                                                               | Six Months Ended                  
|                                                         |                                                                                               |                                   
|                                                         |                                                                                               | June 30,                           |                                           | June 30,                                                
|                                                         |                                                                                               | 2002                               |                                           | 2001                                                    
|                                                         |                                                                                               |                                    |                                           |                                                         
|                                                         |                                                                                               |                                   
|                                                         |                                                                                               | (Unaudited)                       
|                                                         |                                                                                               | (In thousands)                    
|Operating activities                                     |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|                                                         | Net income (loss)                                                                             |                                    | $                                         | (40,024                                                  | )      |         | $       | (648,311 | )       
|                                                         | Adjustments to reconcile net income
    (loss) to the net cash used for operating activities: |                                    |                                           |                                                          |        |         |         |          |         
|                                                         |                                                                                               | Deferred income taxes              |                                           |                                                          |       |         |         |          | (214,480 | )      
|                                                         |                                                                                               | Depreciation                       |                                           |                                                          | 1,469  |         |         |          | 2,917    |        
|                                                         |                                                                                               | Amortization                       |                                           |                                                          | 8,099  |         |         |          | 22,289   |        
|                                                         |                                                                                               | In-process R&D                     |                                           |                                                          |       |         |         |          | 878      |        
|                                                         |                                                                                               | Impairment of long-lived assets    |                                           |                                                          | 72     |         |         |          | 109,067  |        
|                                                         |                                                                                               | (Gain) loss on UMC investment      |                                           |                                                          | (5,132 | )       |         |          | 520,368  |        
|                                                         |                                                                                               | Loss on other investments          |                                           |                                                          | 3,664  |         |         |          | 20,972   |        
|                                                         |                                                                                               | Interest expense accretion         |                                           |                                                          | 1,618  |         |         |          |         |        
|                                                         |                                                                                               | Changes in assets and liabilities: |                                           |                                                          |        |         |         |          |          |        
|                                                         |                                                                                               |                                    | Accounts receivable                       |                                                          |        | (6,266  | )       |          |          | 22,063  |         
|                                                         |                                                                                               |                                    | Inventories                               |                                                          |        | (4,116  | )       |          |          | 19,167  |         
|                                                         |                                                                                               |                                    | Prepaid expenses and other assets         |                                                          |        | (575    | )       |          |          | (2,295  | )       
|                                                         |                                                                                               |                                    | Accounts payable                          |                                                          |        | (8,386  | )       |          |          | (10,124 | )       
|                                                         |                                                                                               |                                    | Accrued liabilities and other liabilities |                                                          |        | (14,650 | )       |          |          | 52,355  |         
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|                                                         |                                                                                               |                                    |                                           | Net cash used for operating activities                   |        |         | (64,227 | )        |          |         | (105,134 | )
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|Investing activities                                     |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|                                                         | Property and equipment purchases                                                              |                                    |                                           | (570                                                     | )      |         |         | (294     | )       
|                                                         | Sales and maturities of short-term investments                                                |                                    |                                           | 38,877                                                   |        |         |         | 125,547  |         
|                                                         | Acquisitions, net of cash acquired                                                            |                                    |                                           |                                                         |        |         |         | (27,600  | )       
|                                                         | Equity investment in technology companies                                                     |                                    |                                           | (700                                                     | )      |         |         |         |         
|                                                         | Other                                                                                         |                                    |                                           | (600                                                     | )      |         |         | (4,234   | )       
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|                                                         |                                                                                               |                                    |                                           | Net cash from (used for) investing activities            |        |         | 37,007  |          |          |         | 93,419   |  
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|Financing activities                                     |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|                                                         | Sale of common stock                                                                          |                                    |                                           | 1,127                                                    |        |         |         | 3,411    |         
|                                                         | Net borrowing (repayments) of notes payable                                                   |                                    |                                           | 683                                                      |        |         |         | (19,866  | )       
|                                                         | Proceeds from convertible debt, net                                                           |                                    |                                           | 58,470                                                   |        |         |         |         |         
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|                                                         |                                                                                               |                                    |                                           | Net cash provided by (used for) financing
    activities |        |         | 60,280  |          |          |         | (16,455  | )
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|Effect of exchange rate changes                          |                                                                                               |                                    | 27                                        |                                                          |        |         | (18     | )       
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|Net increase (decrease) in cash and cash
    equivalents |                                                                                               |                                    | 33,087                                    |                                                          |        |         | (28,188 | )       
|Cash and cash equivalents at beginning of period         |                                                                                               |                                    | 15,251                                    |                                                          |        |         | 36,582  |         
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         
|Cash and cash equivalents at end of period               |                                                                                               | $                                  | 48,338                                    |                                                          |        | $       | 8,394   |         
|                                                         |                                                                                               |                                    |                                           |                                                          |        |         |         |         

See accompanying notes to the unaudited condensed
consolidated financial statements.

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##### Table of Contents



SONICblue INCORPORATED






NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS


1.     Basis of
Presentation

The condensed consolidated financial statements
have been prepared by SONICblue Incorporated, without audit,
pursuant to the rules and regulations of the Securities and
Exchange Commission and include the accounts of SONICblue
Incorporated and its wholly owned subsidiaries
(SONICblue or collectively the Company).
All significant inter-company balances and transactions have
been eliminated. Investments in entities in which the Company
does not have control, but has the ability to exercise
significant influence over operating and financial policies, are
accounted for by the equity method. Certain information and
footnote disclosures, normally included in financial statements
prepared in accordance with generally accepted accounting
principles, have been condensed or omitted pursuant to such
principles and the rules and regulations of the Securities and
Exchange Commission. In the opinion of the Company, the
financial statements reflect all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation
of the financial position at June 30, 2002 and
December 31, 2001, and the operating results and cash flows
for the six months ended June 30, 2002 and 2001. These
financial statements and notes should be read in conjunction
with the Companys audited financial statements and notes
thereto for the year ended December 31, 2001, included in
the Companys Form 10-K filed with the Securities and
Exchange Commission.

The results of operations for the three and six
months ended June 30, 2002 are not necessarily indicative
of the results that may be expected for the future periods or
the year ending December 31, 2002. Certain
reclassifications of 2001 amounts were made in order to conform
to the 2002 presentation.

This Quarterly Report on Form 10-Q contains
forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. In
particular, the Managements Discussion and Analysis
section of this Quarterly Report on Form 10-Q regarding
revenue growth, gross margin trends, amortization of intangible
assets and cost trends contain forward-looking statements and
are qualified by the risks detailed in Factors That May
Affect Our Results and other risks detailed in the
Companys Annual Report on Form 10-K for the year
ended December 31, 2001, and other reports filed by
SONICblue with the Securities and Exchange Commission from time
to time. Actual results could differ materially from those
discussed in this Quarterly Report on Form 10-Q as a result
of the risks described above as well as other risks set forth in
SONICblues periodic reports both previously and hereafter
filed with the Securities and Exchange Commission.

2.     Significant
Transactions



| |                                            
| | -------------------------------------------
| | Purchase of Sensory Science
    Corporation

On June 27, 2001, SONICblue completed the
acquisition of Sensory Science Corporation, a developer of
consumer electronics products, including dual deck videocassette
player/recorders and DVD players. The acquisition was accounted
for as a purchase. At closing, SONICblue issued approximately
1.3 million shares of SONICblue common stock to Sensory
Science stockholders in exchange for the common stock of Sensory
Science outstanding, and Sensory Science became a wholly owned
subsidiary of SONICblue. In connection with the acquisition of
Sensory Science, SONICblue had made loans to Sensory Science in
the amount of $9.8 million, which became part of the
purchase price.

The purchase price of $21.7 million includes
$7.2 million of stock issued at fair value (fair value
being determined as the average price of SONICblue common stock
at the date the exchange ratio was fixed per the merger
agreement), $0.3 million of stock option costs, cash paid
to Sensory Science of $9.8 million and $4.4 million in
estimated expenses of the transaction. The purchase price was
allocated as follows: $(3.1) million to the estimated fair
value of the Sensory Science net tangible assets purchased,
$0.9 million to purchased in-process research and
development, $0.9 million to purchased existing technology,
$1.2 million to trade names, $1.1 million to
workforce-in-place, $5.0 million to distribution channel
relationships and

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SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

$15.7 million to goodwill. Goodwill is
recorded as a result of consideration paid in excess of the fair
value of net tangible and intangible assets acquired,
principally due to estimated synergies of the acquisition.
Identified acquisition related intangible assets are amortized
on a straight-line basis, generally over a five-year period. In
accordance with SFAS 142, goodwill amortization ceased effective
January 1, 2002. The allocation of the purchase price to
intangibles was based upon managements estimates.



| |                           
| | --------------------------
| | Purchase of ReplayTV, Inc.

On August 1, 2001, SONICblue completed the
acquisition of ReplayTV, Inc., a developer of personal
television technology. The acquisition was accounted for as a
purchase. At closing, SONICblue issued 10.4 million shares
of common stock and an aggregate of 5.1 million options and
warrants to purchase shares of SONICblue common stock in
exchange for all of ReplayTVs outstanding equity, and
ReplayTV became a wholly owned subsidiary of SONICblue. In
connection with the acquisition of ReplayTV, SONICblue had made
loans to ReplayTV in the amount of $20.0 million, which
became part of the purchase price.

The purchase price of $50.1 million includes
$26.5 million of stock, $2.8 million of stock option costs,
cash paid to ReplayTV of $20.0 million and $0.8 million in
estimated expenses of the transaction. The purchase price was
allocated as follows: $(43.8) million to the estimated fair
value of the ReplayTV net tangible assets purchased,
$4.2 million to purchased in-process research and
development, $17.5 million to purchased existing and core
technology, $19.5 million to non-compete agreements,
$4.8 million to deferred compensation and
$47.9 million to goodwill. Goodwill is recorded as a result
of consideration paid in excess of the fair value of net
tangible and intangible assets acquired, principally due to
estimated synergies of the acquisition and the value of the
workforce acquired. Goodwill will not be amortized, but will be
reviewed periodically for potential impairment, in accordance
with SFAS 142. The identified acquisition related intangible
assets are amortized on a straight-line basis, generally over a
five-year period. The allocation of the purchase price to
intangibles was based upon a third party appraisal. The purchase
price and the related allocation are subject to further
refinement and change over the next twelve-month period
following the acquisition. Certain elements of the purchase
price allocation are still open to valuation, such as facilities
costs and payables.

3.     Significant
Accounting Policies



| |                    
| | -------------------
| | Revenue Recognition

Revenue for product sales to customers where
(a) persuasive evidence that an arrangement exists,
(b) delivery has occurred or services have been rendered,
(c) our price to the buyer is fixed or determinable, and
(d) collectibility is reasonably assured is recognized upon
product shipment. Revenue for product sales to customers where
one of these criteria are not initially met is deferred until
such criteria have been met. SONICblue recognizes revenue on all
Rio brand players and Diamond brand modems sold through
distributor channels on a sell-through basis deferring all
revenue until product is sold to the final customer. Revenue
from our ReplayTV branded products is recognized ratably over
the estimated service period.

SONICblue records estimated reductions to revenue
for customer programs and incentive offerings, including price
protection, promotions and special pricing agreements. If a
different number of customers redeem incentives than estimated,
additional adjustments to revenue may be required. Accruals for
estimated sales returns are recorded at the time of the sale.
These estimates are based on historical sales returns, analysis
of credit memo data and other known factors. If the historical
data used to calculate these estimates is not representative of
future returns, additional adjustments to revenue may be
required.

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SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |            
| | -----------
| | Inventories

Inventories consist of raw materials, work in
process and finished goods and are stated at the lower of cost
(first-in, first-out) or market. Our products are manufactured,
assembled and tested by contract manufacturers. In determining
market value, we make assumptions about future demand and market
conditions. We utilize a rolling forecast to determine excess
and obsolete or slow moving inventory reserve requirements. We
may apply judgment to the amounts thus identified in
establishing the reserve requirements. If actual conditions are
less favorable than the assumptions used, additional inventory
write-downs may be required.

Inventories consisted of:

|                |       |                |        |              |  |   |        |        | 
|--------------- | ----- | -------------- | ------ | ------------ |  | - | ------ | ------ | 
|                |       | June 30,       |        | December 31,
|                |       | 2002           |        | 2001        
|                |       |                |        |             
|                |       |               
|                |       | (In thousands)
|Raw materials   |       | $              | 1,945  |              |  | $ | 2,819  |       
|Work in process |       |                | 2,417  |              |  |   | 1,188  |       
|Finished goods  |       |                | 20,325 |              |  |   | 16,564 |       
|                |       |                |        |              |  |   |        |       
|                | Total |                | $      | 24,687       |  |   | $      | 20,571 | 
|                |       |                |        |              |  |   |        |       

4.     Investments



| |                  
| | -----------------
| | Investment in UMC

In 1995, SONICblue entered into a joint foundry
venture with United Microelectronics Corporation, or UMC, to
build United Semiconductor Corporation, or USC, a semiconductor
manufacturing facility in Taiwan, R.O.C. In January 2000, USC
merged with UMC and, as a result of the merger SONICblue
received 252 million UMC shares in exchange for
252 million USC shares. The Company also received stock
dividends of approximately 50 and 32 million shares of UMC
stock, in April 2000 and August 2001, respectively. The Company
sold 191 million shares of UMC stock in 2001 and
23 million shares in the first six months of 2002 on the
Taiwan Stock Exchange. Under the terms of the USC merger with
UMC, a portion of the original number of UMC shares received by
SONICblue are subject to restrictions on their sale that lapse
over a three-year period from the date of the merger. At
June 30, 2002, approximately 50 million shares were
subject to restrictions on sale that will lapse in one year or
more and are recorded at adjusted cost as a long-term
investment. The unrestricted shares and shares where the
restrictions will lapse in one year or less are recorded as a
current asset and are marked-to-market value through other
comprehensive income as required by SFAS 115.

At December 31, 2000, the market value of
the investment in UMC had declined to an amount significantly
below its original cost basis. It was determined at that point
that this decline was related to the downturn in the
semiconductor industry as a whole and was temporary in nature
due to the historically cyclical nature of the industry. During
the first half of 2001, the Company concluded that the downturn
in the semiconductor industry and the economy in general
appeared to be more severe than previously anticipated and that
there was a great deal of uncertainty regarding when the
semiconductor industry would recover from this down cycle. At
that time SONICblue concluded that the decline in value of UMC
was other than temporary and it reported an unrealized loss on
the UMC investment of $468 million based on the market
value at June 20, 2001. For the six months ended
June 30, 2002, the Company realized a gain of
$5.1 million related to its sale of 23 million
UMC shares.

As of June 30, 2002, SONICblues
105 million short and long-term UMC shares were worth
approximately $126 million, based on the closing price of
UMC shares on the Taiwan Stock Exchange and the prevailing U.S.
dollar to New Taiwan Dollar exchange rate on that date. The
Companys available-for-sale

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SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

portion of the investment is marked-to-market
through other comprehensive income as required by SFAS 115 for
changes in market value. If any future decline is considered to
be other than temporary, the decrease in value of both the
available-for-sale and long-term portions of the Companys
UMC investment will be recorded as expense in the statement of
operations.

During the first six months of 2002 SONICblue
sold all of its UMC derivative instruments and recorded the gain
of $0.4 million on the income statement in gain
(loss) on other investments for the six months ended
June 30, 2002.



| |                                        
| | ---------------------------------------
| | Interest in Real Estate
    Partnership

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



| |                            
| | ---------------------------
| | Investment in RioPort, Inc.

In October 1999, SONICblue caused RioPort, Inc.
(formerly RioPort.com, Inc.), which was a wholly owned
subsidiary of SONICblue, to sell shares of its preferred stock
to third party investors. RioPort is developing an integrated
platform for acquiring, managing and experiencing music and
spoken audio programming from the Internet. As a result,
SONICblue retains a minority investment in RioPort and accounts
for its investment using the equity method. In addition, in
November 1999, SONICblue received $10.9 million for the
sale to RioPort of OneStep, LLC, a software development company.
In June 2000, RioPort sold additional preferred stock to third
party investors. As part of this financing, the Company invested
an additional $10.7 million in RioPort, maintaining its
percentage ownership of RioPort. In the fourth quarter of 2000,
RioPort sold additional preferred stock to third party
investors. In the first half 2002 the Company provided
$1 million of bridge financing to RioPort along with two
other investors for a total bridge loan of $3 million. As
of June 30, 2002, the Company held approximately 32% of
RioPorts outstanding stock and directors and
officers of the Company held approximately 1% of
RioPorts outstanding stock. The Company recorded its
equity in the loss of RioPort of $2.1 million and
$0.1 million for the six months ended June 30, 2002
and 2001, respectively. As of June 30, 2002, the Company
was a contingent guarantor of RioPorts $2 million
bank line of credit. As of June 30, 2002 the bank balance
was $0.4 million and is included in SONICblues
cumulative reported losses related to RioPort.



| |                           
| | --------------------------
| | Investment in S3-VIA, Inc.

In November 1999, the Company established a 50.1%
majority-owned corporate joint venture with VIA to bring
high-performance integrated graphics and core logic chip sets to
the volume OEM desktop and notebook PC markets. S3-VIA has
exclusive access to both companies technology and
distribution rights for developed products between SONICblue and
VIA. The Company consolidated the accounts of S3-VIA in its
consolidated financial statements through the third quarter of
2001. VIA, acting as S3-VIAs exclusive distributor, orders
product from S3-VIA upon VIAs receipt of a third-party
order. Revenue is recognized by S3-VIA upon shipment to VIA. Net
sales by S3-VIA to VIA and receivables and payables between
S3-VIA and VIA are classified as related party revenues,
receivables and payables in the Companys consolidated
financial statements. In the fourth quarter of 2001, the Company
terminated its participation in the management of S3-VIA. As a
result, the Company wrote off the net assets of the joint
venture, which resulted in an unrecognized gain of
$0.7 million. Since the actual process of withdrawing from
the venture will continue

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##### Table of Contents



SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

and ultimately be a part of other negotiations
that are on-going with VIA, the Company has deferred recognition
of any gain until a comprehensive settlement of all outstanding
issues is reached with VIA.

5.     Intangible
Assets

Intangible assets subject to amortization at
December 31, 2001 totaled $56.5 million, which we
expect will be amortized as follows: $13.6 million for the
year 2002, $12.9 million for the year 2003,
$12.1 million for the year 2004, $10.4 million for the
year 2005 and $6.1 million for the year 2006.

We had goodwill of $75.3 million at
June 30, 2002. Consistent with the implementation of
SFAS 142, we ceased to amortize goodwill beginning
January 1, 2002. In accordance with SFAS 142, we
assess goodwill for impairment on at least an annual basis and
will record any impairment charge in the period of the
assessment. We adopted SFAS 142 on January 1, 2002.
During the second quarter of 2002, we performed the first of the
required impairment tests of goodwill as of January 1,
2002, and determined that no impairment had occurred.

In accordance with SFAS 142, companies are
required in the year of adoption to exclude the impact of
SFAS 142 from comparable interim periods until pre-adoption
periods are no longer presented. The following table adjusts the
Companys net loss to exclude the effects of goodwill and
assembled workforce amortization during the period ended
June 30, 2001:

|                            |                                  |                    |         |      |  |   |          |       | 
|--------------------------- | -------------------------------- | ------------------ | ------- | ---- |  | - | -------- | ----- | 
|                            |                                  |                   
|                            |                                  | Three Months Ended
|                            |                                  | June 30,          
|                            |                                  |                   
|                            |                                  | 2002               |         | 2001
|                            |                                  |                    |         |     
|                            |                                  |                   
|                            |                                  | (In thousands)    
|Reported net loss           |                                  | $                  | (23,456 | )    |  | $ | (312,541 | )    
|Plus FAS 142 adjustments:   |                                  |                    |         |      |  |   |          |      
|                            | Goodwill amortization            |                    |         |     |  |   |          | 9,317 | 
|                            | Assembled workforce amortization |                    |         |     |  |   |          | 187   | 
|                            |                                  |                    |         |      |  |   |          |      
|Adjusted net loss           |                                  | $                  | (23,456 | )    |  | $ | (303,037 | )    
|                            |                                  |                    |         |      |  |   |          |      
|Adjusted net loss per share |                                  | $                  | (0.24   | )    |  | $ | (3.76    | )    

6.     Line of
Credit

Sensory Science Corporation has loans under a
line of credit with a financial institution, which has a
maturity date of March 25, 2003. The maximum line of credit
is $25.0 million with a borrowing limit of
$22.5 million, limited by a borrowing base determined by
specific inventory and receivable balances of Sensory Science
and an availability block of $5.0 million. The line of
credit is collateralized by assets of Sensory Science and by a
guarantee of SONICblue. Interest is charged at prime plus 1.0%.
Borrowings were $16.5 million under this facility at
June 30, 2002. In addition, SONICblue is required to either
hold unencumbered shares of UMC stock with a market value of at
least $40.0 million or deliver to the lender an irrevocable
standby letter of credit with a face amount of at least
$10.0 million.

7.     Earnings
(Loss) Per Share

Basic earnings (loss) per share (EPS)
are computed by dividing income available to common stockholders
by the weighted average number of common shares outstanding for
the period. Diluted EPS reflects the potential dilution that
would occur from any instrument or options, which could result
in additional common shares being issued. When computing
earnings (loss) per share, the Company includes only potential
common shares that are dilutive. Exercise of options and
conversion of convertible debt in the three months

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##### Table of Contents



SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

and six months ended June 30, 2002 and 2001
are not assumed because the result would have been anti-dilutive.

8.     Comprehensive
Income (Loss)

The Companys available-for-sale securities
and foreign currency translation adjustments are included in
other comprehensive income (loss).

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

|                                              |  |                |         |              |  |   |        |  
|--------------------------------------------- |  | -------------- | ------- | ------------ |  | - | ------ | -
|                                              |  | June 30,       |         | December 31,
|                                              |  | 2002           |         | 2001        
|                                              |  |                |         |             
|                                              |  |               
|                                              |  | (In thousands)
|Unrealized gain (loss) on investments         |  | $              | (4,186  | )            |  | $ | 9,390  |  
|Foreign currency translation adjustments      |  |                | (8,370  | )            |  |   | (8,397 | )
|                                              |  |                |         |              |  |   |        |  
|Accumulated other comprehensive income (loss) |  | $              | (12,556 | )            |  | $ | 993    |  
|                                              |  |                |         |              |  |   |        |  

The following schedule of other comprehensive
income (loss) shows the gross current-period income (loss):

|                                          |  |                  |         |      |  |   |         |  
|----------------------------------------- |  | ---------------- | ------- | ---- |  | - | ------- | -
|                                          |  |                 
|                                          |  | Six Months Ended
|                                          |  | June 30,        
|                                          |  |                 
|                                          |  | 2002             |         | 2001
|                                          |  |                  |         |     
|                                          |  |                 
|                                          |  | (In thousands)  
|Net unrealized gain (loss) on investments |  | $                | (13,576 | )    |  | $ | 191,197 |  
|Foreign currency translation adjustments  |  |                  | 27      |      |  |   | (17     | )
|                                          |  |                  |         |      |  |   |         |  
|Other comprehensive income (loss)         |  | $                | (13,549 | )    |  | $ | 191,180 |  
|                                          |  |                  |         |      |  |   |         |  

9.     Contingencies

The Internet, digital media, entertainment and
consumer electronics industries are characterized by frequent
litigation, including litigation regarding patent and other
intellectual property rights. SONICblue is party to various
legal proceedings that arise in the ordinary course of business.
While the Company currently believes that the ultimate outcome
of these proceedings, individually and in the aggregate, will
not have a material adverse effect on the Companys
financial position or overall trends in results of operations,
litigation is subject to inherent uncertainties. There can be no
assurance that an adverse result or settlement with regard to
these lawsuits would not have a material adverse effect on
SONICblues financial condition or results of operations.

Beginning in November 1997, a number of
complaints were filed in federal and state courts seeking
unspecified damages on behalf of an alleged class of persons who
purchased shares of SONICblues common stock at various
times between April 18, 1996, and November 3, 1997.
The complaints named as defendants SONICblue, certain of its
officers and former officers, certain directors of SONICblue,
and Deloitte & Touche, the companys former auditors,
and asserted that they violated federal and state securities
laws by misrepresenting and failing to disclose certain
information about SONICblues business. In addition,
certain stockholders filed derivative actions in the state
courts of California and Delaware seeking recovery on behalf of
SONICblue, alleging, among other things, breach of fiduciary
duties by such individual defendants. The plaintiffs in the
derivative action in Delaware took no steps to pursue their
case. The derivative cases in California State court were
consolidated, and plaintiffs filed a consolidated amended
complaint. The court entered a stipulated order in those
derivative cases suspending court proceedings and coordinating
discovery in them with discovery in the class actions in
California State courts. In late 2001, the derivative plaintiffs
gave

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SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

notice terminating that stay, and the parties
stipulated that a second amended consolidated complaint might be
filed in April 2002. On plaintiffs motion, the federal
court dismissed the federal class actions without prejudice. The
class actions in California State court were consolidated, and
plaintiffs filed a consolidated amended complaint. SONICblue
answered that complaint and discovery proceeded. In January
2001, four of the insurance carriers which issued directors and
officers insurance to SONICblue filed suit against all parties
named as defendants in the securities litigation, claiming that
the carriers have no obligation to provide coverage under the
California Insurance Code. In May 2001, the court entered an
order staying the insurance action pending resolution of the
securities litigation. In February 2002, the California Superior
Court for Santa Clara County entered its preliminary approval of
an agreement to settle the consolidated state court class action
lawsuit. Under the terms of the class action settlement,
SONICblue will contribute 2,401,501 shares of SONICblue
common stock and Deloitte & Touche will contribute up
to $250,000 in full settlement of all claims. In April 2002, the
Superior Court granted final approval to that settlement,
dismissing the case. In May 2002, the Superior Court also
approved the settlement of the related California derivative
litigation. The derivative settlement calls for the defendants
to contribute to the settlement their respective benefits under
certain directors and officers insurance policies in an amount
of approximately $4.6 million which, net of attorneys
fees and litigation costs, would be paid to SONICblue, which
payments have been made. The total net cost of these settlements
to SONICblue, net of insurance, is expected to approximate $8.6
million. These charges were recorded in SONICblues fourth
quarter ended December 31, 2001. In addition the Company
settled the claim of a purchaser of the Companys common
stock in 1996 and 1997, by payment of $100,000 and
300,000 shares of the Companys common stock, the net
cost of which was recorded in the quarter ended March 31,
2002. The judgments in the class action and the derivative
litigation are both final, and the insurance litigation has been
dismissed.

SONICblue has also been defending several
putative class action lawsuits naming Diamond, which were filed
in June and July 1996 and June 1997 in the California Superior
Court for Santa Clara County and the U.S. District Court for the
Northern District of California. The plaintiffs alleged that
Diamond and the other defendants made various material
misrepresentations and omissions during the class period. The
parties have agreed to settle this matter for a payment of
$15.0 million, and final court approval of that settlement
was obtained, and the cases dismissed, in April 2002. SONICblue
funded $4.5 million of the settlement in November 2000.
SONICblue previously accrued this amount in connection with the
merger with Diamond. SONICblue believes that Diamonds
insurance covers the remaining $10.5 million of the
settlement; Diamonds insurers have funded that amount into
the settlement, although one of these insurers has commenced
arbitration disputing its obligation to pay $3.0 million of the
$10.5 million. The contesting insurer maintains that
indemnification of its share of the settlement is barred by
virtue of a recent California appellate decision. The
arbitration tribunal issued an order in April 2002, stating that
the California state law claim in the class action was
uninsurable, but that factual questions were presented as to the
allocation of the settlement amount as between the state law
claim and other claims included in the settlement documents.
Further proceedings are contemplated before the tribunal, but no
schedule has as yet been set.

On February 14, 2000, Robert C. Price filed
a purported class action lawsuit in the Circuit Court of Monroe
County, State of Indiana against the Company and Diamond
alleging violations of the California Business and Professions
Code section 17200 and the California Song-Beverly Act, which
covers consumer warranties. The lawsuit alleges that certain of
the Companys Rio 300 MP3 player retail boxes, which were
discontinued in approximately 1999, are misleading because the
boxes indicate that computer software included in the package
allows the purchaser to convert audio tracks on CDs to the MP3
audio format, but the software included with the product
permitted only 50 conversions. The Company answered the
complaint on April 27, 2000, denying plaintiffs
allegations. Status conferences were conducted on July 26,
2000, January 10, 2001, and April 17, 2002. Discovery
has commenced. No class has been certified, but the briefing on
the plaintiffs motion for class certification is expected
to be completed by Fall 2002, with a hearing on class

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SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

certification issues to be scheduled thereafter.
SONICblue intends to contest the certification of the purported
class, dispute the lawsuits allegations and defend this
action vigorously.

In October and November, 2001, a group of 28
entertainment companies including, among others, Paramount
Pictures Corporation, Disney Enterprises, Inc. and the three
major television networks filed four lawsuits against SONICblue
and its ReplayTV, Inc. subsidiary in the U.S. District Court in
Los Angeles, California. The lawsuits allege that the
Companys planned manufacture and sale of the ReplayTV
4000, which allows users to skip commercials and to use the
Internet to send recorded material to other ReplayTV 4000 users,
constitutes copyright infringement, among other claims. The
plaintiffs in the lawsuits are seeking an injunction prohibiting
the Company from including these features in its video products.
Although one of the lawsuits originally alleged that the
Companys Go-Video VCRs featuring the commercial skipping
technology similarly violate the copyright laws, in their
amended complaint plaintiffs eliminated these claims in November
2001. The parties have commenced discovery. The District Court
preliminarily scheduled a consolidated trial in August 2002 but
removed the trial from its calendar in April 2002 and has not
set a new trial date. SONICblue intends to dispute the
plaintiffs claims and defend this action vigorously.

In June, 2002, a group of five individual
ReplayTV 4000 owners filed a lawsuit in the United States
District Court in Los Angeles against the 28 entertainment
companies described above, seeking a declaration that their use
of the ReplayTV 4000 device is fair use and does not infringe
copyrights. Those individuals named SONICblue and its ReplayTV,
Inc. subsidiary as nominal defendants, although those
individuals interests are substantially aligned with the
Companys position. This complaint does not demand any
affirmative relief against the Company, but purports to reserve
the right to amend to seek an injunction to prohibit the Company
from discontinuing support for features that were advertised or
served as inducements for consumers purchases, absent
restitution to such consumers.

In November 2001, Pac Tec, a division of La
France Corporation, filed a civil action against the Company and
one of its suppliers, Manufacturers Services Limited, in
the United States District Court for the Eastern District of
Pennsylvania, alleging claims against both defendants jointly
for breach of contract and promissory estoppel. The plaintiff
seeks damages in excess of $2.5 million, plus prejudgment
interest and costs of suit. In February 2002, the Company filed
a motion to dismiss the complaint, which the plaintiff has
opposed. The judge has not set a hearing date for the motion.
SONICblue intends to dispute the plaintiffs claims and
vigorously defend itself against this action.

In November 2001, four former holders of ReplayTV
preferred shares filed a petition for appraisal in the Chancery
Court in the State of Delaware asserting their dissenters rights
of appraisal and seeking the fair value of their ReplayTV shares
in cash in lieu of the SONICblue shares to be issued to them as
provided in SONICblues merger agreement with ReplayTV. In
December 2001, ReplayTV filed its response to plaintiffs
petition. In addition, in December 2001, the same four former
holders of ReplayTV preferred shares filed a complaint in the
Chancery Court in the State of Delaware asserting that ReplayTV
and its former directors breached their fiduciary duties in
connection with Replay TVs merger by engaging in
self-dealing, failing to make appropriate disclosures to
shareholders and failing to maximize the value for them in the
merger, resulting in an allocation of an insufficient amount of
the merger consideration to the ReplayTV preferred stockholders.
The complaint seeks at least $7,249,990.50 in
damages. In its merger agreement with ReplayTV, SONICblue agreed
to indemnify ReplayTVs former directors against this type
of lawsuit, among other things. In February 2002, ReplayTV and
the former ReplayTV directors filed their answer. SONICblue and
ReplayTV intend to dispute the plaintiffs claims and
vigorously defend these actions. The cases are currently in the
pretrial discovery stage.

On November 28, 2001, Techsearch, LLC filed
a complaint for patent infringement against a number of consumer
electronics companies, including SONICblue, in the United States
District Court for the Northern District of Illinois.
Techsearchs complaint generally alleges that SONICblue is
infringing one of its patents by

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SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

making, selling, and offering to sell its Rio
Volt CD players that are capable of playing CDs encoded with
audio tracks in the MP3 format. SONICblue intends to dispute the
plaintiffs claims and vigorously defend itself against the
allegations made in Techsearchs complaint. This action was
stayed by order of the Court on or about May 1, 2002,
pending a reexamination of the patent asserted by Techsearch by
the U.S. Patent and Trademark Office.

On December 12, 2001, SONICblue filed a
complaint for patent infringement against TiVo, Inc. in the
United States District Court for the Northern District of
California. SONICblues complaint generally alleges that
TiVo is infringing one of its patents by licensing and offering
to license its DVR technology and offering its program guide
service. In response, TiVo filed an answer and counterclaim
against SONICblue that denies infringement of SONICblues
patent and that alleges that the patent is invalid. On
January 23, 2002, TiVo filed a separate action in the same
court, but assigned to a different judge, that generally alleges
that SONICblue is infringing one of TiVos patents by
making, selling and offering to sell its ReplayTV DVRs. The
parties have agreed to suspend further proceedings in the two
cases through Fall 2002 to facilitate settlement discussions
between them. If the cases do not settle, SONICblue intends to
vigorously defend itself against the allegations made in
TiVos complaint and counterclaim.

On October 17, 2001, Skyline Capital
Associates, LLC filed a lawsuit in the San Mateo County
Superior Court alleging that SONICblue breached an agreement for
tax consulting services and seeking payment of $3.2 million
for consulting fees and interest. In November 2001, SONICblue
filed a counter claim against Skyline for $750,000. In March
2002, SONICblue, Skyline and Skylines principal entered
into a settlement agreement pursuant to which the parties would
resolve their dispute for $2.4 million. In June 2002, after
SONICblue had paid approximately $2.3 million under the
settlement agreement, a dispute over the settlement arose. As of
the date of this report, Skyline has not responded to
SONICblues attempts to engage Skyline in discussion
regarding a final resolution of this matter.

The investment agreement between SONICblue, VIA
and S3 Graphics provides that under certain circumstances,
SONICblue may be required to pay VIA significant liquidated
damages if, unless as a result of certain acts or omissions on
the part of either VIA or S3 Graphics, S3 Graphics is prevented
by court order from utilizing SONICblues patent
cross-license with Intel Corporation or if SONICblue enters into
a settlement agreement with Intel such that S3 Graphics can no
longer operate under the patent cross-license. In September
2001, Intel filed a patent infringement lawsuit against S3
Graphics and VIA. SONICblue is not a party to the lawsuit. The
lawsuit is in early stages. Any liquidated damages that
SONICblue might be required to pay to VIA under the investment
agreement may under certain circumstances be reduced by amounts
paid by SONICblue to Intel in connection with any lawsuit and
amounts owed to SONICblue by either VIA or S3 Graphics.

While we currently believe that the ultimate
outcome of these proceedings will not have a material adverse
effect on the Companys financial position or overall
trends in results of operations, litigation is subject to
inherent uncertainties. An adverse result or settlement with
regard to these proceedings could have a material adverse effect
on SONICblues financial condition or results of operations.

10.     New
Accounting Pronouncements

On July 30, 2002, the Financial Accounting
Standards Board issued Statement of Financial Accounting
Standards Statement No. 146, Accounting for Costs
Associated with Exit or Disposal Activities(SFAS
No. 146). The standard replaces EITF Issue No. 94-3,
Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring) and requires companies
to recognize costs associated with exit or disposal activities
when they are incurred rather than at the date of a commitment
to an exit or disposal plan. Examples of costs covered by the
standard include lease termination costs and certain employee
severance costs that are associated with a

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SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

restructuring, discontinued operation, plant
closing, or other exit or disposal activity. SFAS 146 is
effective prospectively to exit or disposal activities initiated
after December 31, 2002.

In August 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS 144 addresses financial
accounting and reporting for the impairment of long-lived assets
and for long-lived assets to be disposed of. The provisions of
SFAS 144 were effective January 1, 2002. The adoption
of SFAS 144 did not have an impact on the Companys
consolidated financial position and results of operations.

11.     Restructuring
Expense and Impairment Charge

In April 2001, the Company adopted a
restructuring plan relating to the change in its business
strategy to address changes in the market due to technology
changes, customer demands, and methods of distribution to
reflect its long-term strategy and focus. Specific actions taken
in 2001 included reducing the Companys workforce worldwide
by approximately 200 employees, consolidating facilities,
discontinuing unprofitable products and closing offices in
unprofitable locations. Restructuring expenses of
$130 million in 2001 related to the restructuring plan
primarily included the write-off of goodwill and other
intangibles ($110 million), facilities closure expenses
($9 million), personnel severance compensation and related
expenses ($6 million) and contract termination and other
costs ($5 million). As part of the restructuring, the
Company also wrote off $60 million of inventory, through
cost of sales in 2001.

Due to the circumstances created by the
significant downturns in the digital media markets, the Company
recorded an impairment charge against the goodwill and
intangibles associated with its acquisitions of Diamond
Multimedia, RioPort, and Empeg Limited. These downturns
negatively affected the forecasted revenues and cash flows from
the Diamond and Empeg Limited businesses acquired in 1999 and
2000, respectively. In accordance with the Companys
policy, undiscounted cash flows indicated that the assets were
impaired. The Company calculated the impairment charge by
comparing the expected discounted future cash flows to the
carrying amount of the related intangible assets.

In the first six months of 2002, the Company
continued the restructuring efforts described above. Specific
actions taken included a further reduction of the Companys
workforce worldwide by approximately 50 employees and
consolidation of facilities. Restructuring expenses of
$13.6 million in the first half of 2002 related to the
restructuring plan included personnel severance compensation and
related expenses ($1.8 million), and facilities related
expenses and other costs ($11.8 million).

The related accrued restructuring charges
activity was as follows:

|                             |                       |                  |       |               |   |              |        |        |   |   |       |      |   |   |        |        |  
|---------------------------- | --------------------- | ---------------- | ----- | ------------- | - | ------------ | ------ | ------ | - | - | ----- | ---- | - | - | ------ | ------ | -
|                             |                       | Severance        |       | Redundant     |   |              |        |       
|                             |                       | Compensation and |       | Facilities    |   | Contract and |        |       
|                             |                       | Related Expenses |       | Related Costs |   | Other Costs  |        | Total 
|                             |                       |                  |       |               |   |              |        |       
|                             |                       |                 
|                             |                       | (In thousands)  
|Balance at December 31, 2001 |                       | $                | 2,643 |               |   | $            | 6,563  |        |   | $ | 1,387 |      |   | $ | 10,593 |       
|                             | Restructuring Charges |                  |       | 1,800         |   |              |        | 12,263 |   |   |       | (432 | ) |   |        | 13,631 |  
|                             | Cash Payments         |                  |       | (1,769        | ) |              |        | (1,575 | ) |   |       | (396 | ) |   |        | (3,740 | )
|                             | Non-Cash Charges      |                  |       |              |   |              |        |       |   |   |       |     |   |   |        |       |  
|                             |                       |                  |       |               |   |              |        |        |   |   |       |      |   |   |        |       
|Balance at June 30, 2002     |                       | $                | 2,674 |               |   | $            | 17,251 |        |   | $ | 559   |      |   | $ | 20,484 |       
|                             |                       |                  |       |               |   |              |        |        |   |   |       |      |   |   |        |       

12.     Senior
Subordinated Convertible Debt

In April 2002, we completed a private placement
of $75.0 million in aggregate principal amount of our
7 3/4% secured senior subordinated convertible debentures
due 2005 to three institutional investors. We also

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SONICblue INCORPORATED


NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

issued warrants to purchase up to
7,500,000 shares of our common stock in the transaction to
the investors, and a warrant to purchase 293,805 shares of
our common stock to the placement agent for the transaction. The
private placement resulted in gross proceeds to us, prior to the
exercise of the warrants, of approximately $62.3 million.
The sale of the debentures and the warrants closed on
April 22, 2002. The debentures are convertible into
SONICblue common stock at a conversion price of $19.22 per share
subject to standard anti-dilution adjustments. The warrants are
fully vested and exercisable at any time until April 22,
2007 at an exercise price of $3.39 per share subject to standard
anti-dilution adjustments. Our repayment obligation on the
debentures is secured by a pledge of 21,426,586 shares of
UMC stock. The institutional investors also have an option to
purchase these UMC shares from us. The value of these equity
instruments and the discount on the face value of the debt have
been recorded as an offset to the $75 million face value of
the debt on the balance sheet at June 30, 2002. These items
are amortized to interest expense under the effective interest
method over the term of the debentures. Under the terms of the
debentures we may pay up to 50% of the interest payments on the
debentures in shares of our common stock.

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

When used in this discussion, the words
expects, anticipates,
believes, estimates and similar
expressions are intended to identify forward-looking statements.
These statements, which include statements as to the
Companys sources of revenues, development of technology
and products, product mix, the percentage of net sales
represented by any particular new or current product, customer
concentration, trends in average selling prices, seasonality and
trends in shipment levels, the percentage of export sales,
interest charges and fees associated with the Companys
outstanding debt and bank financing, income tax benefits, the
use of the proceeds from the Companys private financing of
its secured senior subordinated convertible debentures, trends
in net loss, net income, gross margins and cash flow, expected
cash requirements, expected expense levels and plans to reduce
expenses and focus on core technology and products, the
availability and cost of products from the Companys
suppliers, ability to compete, investments in research and
development, capital expenditures, capital requirements and
adequacy of capital resources, expected stock dividends from our
UMC stock, plans regarding future financing alternatives, the
impact and timing of the Companys current and future
litigation, the Companys strategy with regard to
protecting its proprietary technology and the Companys
ability to forecast demand for its products, are subject to
risks and uncertainties that could cause actual results to
differ materially from those projected. These risks and
uncertainties include, but are not limited to, those risks
discussed below, as well as risks relating to SONICblues
ability to develop and timely introduce and ship in volume
products that address market demands, manufacturing
difficulties, the cost and availability of component products,
the Companys ability to negotiate with vendors for lower
prices, decreases in average selling prices, timing and volume
of shipments of new products, SONICblues ability to work
with strategic partners and OEMs, the ability of the Company to
obtain and retain customers, the impact of alternative
technological advances and competitive products, the value of
the Companys shares of UMC common stock and declines in
the semiconductor industry, market fluctuations, developments in
and expenses relating to litigation, SONICblues ability to
complete business transactions and integrate acquired businesses
in a timely manner, the costs of integrating acquired businesses
and technologies, and the matters discussed in Factors
That May Affect Our Results. These forward-looking
statements speak only as of the date hereof. The Company
expressly disclaims any obligation or undertaking to release
publicly any updates or revisions to any forward-looking
statements contained herein to reflect any change in the
Companys expectations with regard thereto or any change in
events, conditions or circumstances on which any statement is
based.

Overview

SONICblue designs, develops and markets products
for the converging Internet, digital media, entertainment and
consumer electronics markets. Our products include Rio digital
audio players, ReplayTV personal television technology and
software solutions, and Go-Video Dual-Deck VCRs and integrated
DVD+VCRs. Prior to the transfer in January 2001 of our graphics
chips business to S3 Graphics Co., Ltd., we were a supplier of
graphics and multimedia accelerator subsystems for PCs for over
ten years.

Acquisitions and Divestitures

On August 1, 2001, SONICblue completed the
acquisition of ReplayTV, Inc., a developer of personal
television technology. The acquisition was accounted for as a
purchase. At closing, SONICblue issued 10.4 million shares
of common stock and assumed an aggregate of 5.1 million
options and warrants to purchase shares of SONICblue common
stock in exchange for all of ReplayTVs outstanding equity,
and ReplayTV became a wholly owned subsidiary of SONICblue.
Prior to closing the acquisition, SONICblue made loans to
ReplayTV in the amount of $20.0 million, which became part
of the purchase price.

On June 27, 2001, SONICblue completed the
acquisition of Sensory Science Corporation, a developer of
consumer electronics products, including dual deck videocassette
player/recorders and DVD players. The acquisition was accounted
for as a purchase. At closing, SONICblue issued approximately
1.3 million shares of SONICblue common stock to Sensory
Science stockholders in exchange for the common stock of Sensory
Science outstanding, and Sensory Science became a wholly owned
subsidiary of SONICblue. Prior to closing the acquisition,
SONICblue made loans to Sensory Science in the amount of
$9.8 million, which became part of the purchase price.

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In March 2001, SONICblue completed the sale to
ATI Technologies, Inc. (ATI) of its professional
graphics division, based in Starnberg, Germany, which produced
the Fire GL line of graphics accelerators. Under the terms of an
Asset Purchase Agreement, SONICblue has received
$7.9 million in cash through June 30, 2002, and is
eligible to receive further financial consideration of up to
$2.1 million contingent upon the Fire GL graphics business,
as operated by ATI, achieving future performance targets.

In January 2001, SONICblue completed the transfer
of its graphics chips net assets, other than its shares of
common stock of S3-VIA, Inc. (S3-VIA), to S3
Graphics Co., Ltd. (S3 Graphics), a joint venture
between VIA Technologies, Inc. (VIA) and a wholly
owned subsidiary of SONICblue. The joint venture manufactures
and distributes semiconductor products and conducts related
research and development activities. Pursuant to the joint
venture agreement with VIA, SONICblue received 13 million
shares of SONICblue common stock in return for a reduction of
its economic interest in the future operations of the joint
venture to 0.1%. Under the joint venture agreement, SONICblue
will also receive earn-out payments if the venture meets
specified profitability goals.

In November 2000, SONICblue acquired United
Kingdom digital audio equipment manufacturer Empeg Limited,
known as empeg, at an initial purchase price of
$1.9 million. This acquisition was accounted for as a
purchase. In November 2001, a purchase price adjustment of
$1.1 million was recorded resulting in a total purchase
price of $3.0 million.

In August 2000, SONICblue shut down its Diamond
Multimedia-branded graphics add-in board business. The shutdown
did not extend to SONICblues professional graphics
division, headquartered in Germany, which continued to develop
and market its line of Fire GL graphics accelerators until, as
discussed above, SONICblue sold its professional graphics
division to ATI Technologies.

Results of Operations

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

|                                  |                                                                     |                          |       |                  |      |          |          |          |       |  |       |      |      |  |          |       |       | 
|--------------------------------- | ------------------------------------------------------------------- | ------------------------ | ----- | ---------------- | ---- | -------- | -------- | -------- | ----- |  | ----- | ---- | ---- |  | -------- | ----- | ----- | 
|                                  |                                                                     |                          |       |                 
|                                  |                                                                     | Three Months Ended       |       | Six Months Ended
|                                  |                                                                     |                          |       |                 
|                                  |                                                                     | June 30,                 |       | June 30,         |      | June 30, |          | June 30,
|                                  |                                                                     | 2002                     |       | 2001             |      | 2002     |          | 2001    
|                                  |                                                                     |                          |       |                  |      |          |          |         
|Net sales                         |                                                                     |                          | 100.0 | %                |      |          | 100.0    | %        |       |  | 100.0 | %    |      |  | 100.0    | %    
|Cost of sales                     |                                                                     |                          | 79.0  |                  |      |          | 328.8    |          |       |  | 80.5  |      |      |  | 206.2    |      
|                                  |                                                                     |                          |       |                  |      |          |          |          |       |  |       |      |      |  |          |      
|Gross profit (loss)               |                                                                     |                          | 21.0  |                  |      |          | (228.8   | )        |       |  | 19.5  |      |      |  | (106.2   | )    
|Operating expenses:               |                                                                     |                          |       |                  |      |          |          |          |       |  |       |      |      |  |          |      
|                                  | Research and development                                            |                          |       | 6.6              |      |          |          | 21.8     |       |  |       | 6.6  |      |  |          | 21.6  |      
|                                  | Selling, marketing and administrative                               |                          |       | 22.6             |      |          |          | 115.6    |       |  |       | 23.2 |      |  |          | 74.3  |      
|                                  | Restructuring, impairment and in-process R&D                        |                          |       | 11.2             |      |          |          | 417.2    |       |  |       | 10.8 |      |  |          | 155.0 |      
|                                  | Amortization of goodwill, intangibles and
    deferred compensation |                          |       | 6.5              |      |          |          | 37.8     |       |  |       | 6.4  |      |  |          | 28.1  |      
|                                  |                                                                     |                          |       |                  |      |          |          |          |       |  |       |      |      |  |          |      
|                                  |                                                                     | Total operating expenses |       |                  | 46.9 |          |          |          | 592.4 |  |       |      | 47.0 |  |          |       | 279.0 | 
|                                  |                                                                     |                          |       |                  |      |          |          |          |       |  |       |      |      |  |          |      
|Loss from operations              |                                                                     |                          | (25.9 | )                |      |          | (821.2   | )        |       |  | (27.5 | )    |      |  | (385.2   | )    
|Gain (loss) on UMC investment     |                                                                     |                          | 1.1   |                  |      |          | (236.9   | )        |       |  | 4.1   |      |      |  | (665.0   | )    
|Gain (loss) on other investments  |                                                                     |                          | (4.7  | )                |      |          | (70.7    | )        |       |  | (2.9  | )    |      |  | (27.2    | )    
|Interest expense                  |                                                                     |                          | (7.8  | )                |      |          | (10.3    | )        |       |  | (5.2  | )    |      |  | (7.7     | )    
|Other income (expense), net       |                                                                     |                          | (0.7  | )                |      |          | (3.7     | )        |       |  | (0.1  | )    |      |  | (1.3     | )    
|                                  |                                                                     |                          |       |                  |      |          |          |          |       |  |       |      |      |  |          |      
|Income (loss) before income taxes |                                                                     |                          | (38.0 | )                |      |          | (1,142.8 | )        |       |  | (31.6 | )    |      |  | (1,086.4 | )    
|Income tax expense (benefit)      |                                                                     |                          | 0.0   |                  |      |          | (83.6    | )        |       |  | 0.0   |      |      |  | (269.8   | )    
|                                  |                                                                     |                          |       |                  |      |          |          |          |       |  |       |      |      |  |          |      
|Net income (loss)                 |                                                                     |                          | (38.0 | )%               |      |          | (1,059.2 | )%       |       |  | (31.6 | )%   |      |  | (816.6   | )%   
|                                  |                                                                     |                          |       |                  |      |          |          |          |       |  |       |      |      |  |          |      

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| |          
| | ---------
| | Net Sales

Our products are used in, and our business is
dependent upon, the converging Internet, digital media,
entertainment and consumer electronics markets. Sales of our
products are primarily in the United States and to a lesser
extent in Asia and Europe.

Net sales were $61.7 million for the three
months ended June 30, 2002, an increase of 109% from
$29.5 million for the three months ended June 30,
2001. Net sales were $126.7 million for the six months
ended June 30, 2002, an increase of 60% from
$79.4 million for the six months ended June 30, 2001.
Net sales increased from 2001 to 2002 primarily due to the
inclusion of sales from our recent acquisitions of Sensory
Science and, to a lesser extent, ReplayTV. Net sales for the
first six months of 2002 consisted primarily of consumer
electronics products, including our Rio branded digital audio
players, Sensory Science video products and to a lesser extent
our Diamond brand modems. Net sales for the first six months of
2001 consisted primarily of our Diamond brand modems, PDA and
communications products, Rio digital audio players and net sales
from our S3-VIA joint venture.

We expect that the percentage of our net sales
represented by any one product or type of product may change
significantly from period to period as new products are
introduced and existing products reach the end of their life
cycles. We anticipate that the majority of our revenues will be
generated from our consumer electronics product lines and to a
lesser extent our modem product line. No further significant
revenues are anticipated from chips, boards or S3-VIA, Inc. Due
to competitive price pressures, our products experience
declining average selling prices over time, which at times can
be substantial.

International sales accounted for 5% and 33% of
net sales for the three months ended June 30, 2002 and
2001, respectively. International sales accounted for 5% and 50%
of net sales for the six months ended June 30, 2002 and
2001, respectively, excluding the net sales of S3-VIA, Inc.
International sales decreased as a result of our shift in
business and focus on the converging Internet, digital media,
entertainment and consumer electronics markets which are
predominantly domestic sales. There can be no assurances that
international sales as a percentage of net sales will remain at
current levels. All sales transactions are denominated in
U.S. dollars.

Four retailers accounted for 31%, 15%, 15% and
14% of net sales in the three months ended June 30, 2002.
Two customers accounted for 12% and 11% of net sales for the
three months ended June 30, 2001, excluding the sales of
S3-VIA, Inc. Four retailers accounted for 28%, 17%, 13% and 12%
of net sales in the six months ended June 30, 2002. Two
customers accounted for 12% and 10% of net sales in the six
months ended June 30, 2001. We expect a significant portion
of our future sales to remain concentrated within a limited
number of strategic customers. Sales to any particular customer
may fluctuate significantly from quarter to quarter.



| |             
| | ------------
| | Gross Margin

We had a positive gross margin of 21.0% for the
three months ended June 30, 2002, as compared with a
negative gross margin of 228.8% for the three months ended
June 30, 2001. The increase in gross margin in the second
quarter was primarily the result of adding the Sensory Science
product lines, supply chain management efficiencies and a
$4.8 million benefit from the favorable resolution of
previously outstanding obligations to one of our contract
manufacturers. We had a positive gross margin of 19.5% for the
six months ended June 30, 2002, as compared with a negative
gross margin of 106.2% for the six months ended June 30,
2001. The increase in gross margin for the six months ended
June 30, 2002, was primarily the result of adding the
Sensory Science product lines, supply chain management
efficiencies, and decreased liabilities for certain purchase
commitments with one of our contract manufacturers. The increase
in gross margin for the six months ended June  30, 2002,
was partially offset by declining average selling prices within
our video product line, increased costs from the introduction of
new products and related product transition costs. In the
future, our gross margins will be affected by increased
competition and related decreases in the unit average selling
prices, particularly within the video product line, our ability
to reduce costs by negotiating with vendors for more favorable
pricing, the timing and volume of shipments of new products, the
availability of products from

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our suppliers, changes in the mix of products
sold and the extent to which we incur or obtain additional
licensing fees.




| |                                      
| | -------------------------------------
| | Research and Development
    Expenses

Research and development expenses consist
primarily of salaries, related benefits, and fees for consulting
and outsourced services. We have made and intend to continue to
make significant investments in research and development to
remain competitive by developing new and enhanced products.
Research and development expenses were $4.1 million for the
three months ended June 30, 2002, a decrease of
$2.3 million from $6.4 million for the three months
ended June 30, 2001. Research and development expenses were
$8.4 million for the six months ended June 30, 2002, a
decrease of $8.7 million from $17.1 million for the
six months ended June 30, 2001. This decrease was primarily
due to a reduction in headcount and related personnel costs
resulting from the shutdown of our multimedia board business and
the transfer of our graphics chips business. We intend to
continue to focus on core technology and products while
concentrating on efforts to reduce overhead, headcount and
related costs.



| |                                                   
| | --------------------------------------------------
| | Selling, Marketing and Administrative
    Expenses

Selling, marketing and administrative expenses
consist primarily of salaries, related benefits, selling costs,
facilities costs and fees for professional services, such as
legal and accounting services. Selling, marketing and
administrative expenses were $14.0 million for the three
months ended June 30, 2002, a decrease of
$20.1 million from $34.1 million for the three months
ended June 30, 2001. Selling, marketing and administrative
expenses were $29.4 million for the six months ended
June 30, 2002, a decrease of $29.6 million from
$59.0 million for the six months ended June 30, 2001.
Selling, marketing and administrative expenses decreased
primarily due to a reduction in headcount and related personnel
costs resulting from the shutdown of our multimedia board
business and the transfer of our graphics chips business and
restructuring activities in 2001.



| |                                                 
| | ------------------------------------------------
| | Restructuring, Impairment and In-process
    R&D

Restructuring and impairment charges were
$6.9 million and $13.6 million for the three and six
months ended June 30, 2002, respectively as compared to $0
and $122.2 million for the three and six months ended
June 30, 2001, respectively. In-process R&D charges
were $0 for the three and six months ended June 30, 2002,
as compared to $0.9 million for the three and six months
ended June 30, 2001. The in-process R&D charge related
to our acquisition of Sensory Science in the second quarter
2001. In accordance with our restructuring plan adopted in April
2001, we have taken specific actions to address changes in our
business strategy, changes in the market due to technology
changes, customer demands and methods of distribution to reflect
our long-term strategy and focus. Restructuring expenses consist
primarily of the write-off of goodwill and intangibles,
facilities consolidation and closure expenses, personnel
severance compensation and related expenses and contract
termination and other costs. We expect such restructuring
activities to continue in the second half of 2002.



| |                                                                    
| | -------------------------------------------------------------------
| | Amortization of Goodwill, Intangibles and
    Deferred Compensation

Amortization of goodwill and intangibles
decreased to $3.3 million for the three months ended
June 30, 2002, down from $11.2 million for the three
months ended June 30, 2001. Amortization of goodwill and
intangibles decreased to $6.8 million for the six months
ended June 30, 2002, down from $22.3 million for the
six months ended June 30, 2001. This decrease is due to the
write off in 2001 of approximately $110 million of goodwill
and other intangibles, primarily related to the acquisition of
Diamond Multimedia Systems, Inc. and the implementation of
Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets
(SFAS 142). Deferred compensation expense
increased to $0.7 million for the three months ended
June 30, 2002, up from $0 for the three months ended
June 30, 2001, and to $1.3 million for the six months
ended June 30, 2002, up from $0 for the six months ended
June 30, 2001. This increase resulted from the acquisition
of ReplayTV, Inc. in August 2001.

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Amortization charges will continue to decrease in
2002 when compared to prior years due to the impact of the 2001
write off noted above and the implementation of SFAS 142.
SFAS 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized but be reviewed
at least annually for impairment. Intangible assets with finite
useful lives will continue to be amortized over their respective
useful lives.

Excluding the adoption of SFAS 142, goodwill
amortization expense would have been an incremental
$4.2 million and $8.4 million for the three and six
months ended June 30, 2002, respectively. Total
amortization charges for goodwill, intangibles and deferred
compensation would have been $8.2 million and
$16.5 million for the three and six months ended
June 30, 2002, respectively, compared to $11.2 million
and $22.3 million for the three and six months ended
June 30, 2001, respectively.



| |                              
| | -----------------------------
| | Gain (Loss) on UMC Investment

In 1995, SONICblue entered into a joint foundry
venture with United Microelectronics Corporation, or UMC, to
build United Semiconductor Corporation, or USC, a semiconductor
manufacturing facility in Taiwan, R.O.C. In January 2000, USC
merged with UMC and, as a result of the merger SONICblue
received 252 million UMC shares in exchange for
252 million USC shares. The Company also received stock
dividends of approximately 50 and 32 million shares of UMC
stock, in April 2000 and August 2001, respectively. The Company
sold 191 million shares of UMC stock in 2001 and
23 million shares in the first six months of 2002 on the
Taiwan Stock Exchange. Under the terms of the USC merger with
UMC, a portion of the original number of UMC shares received by
SONICblue are subject to restrictions on their sale that lapse
over a three-year period from the date of the merger. At
June 30, 2002, approximately 50 million shares were
subject to restrictions that will lapse in one year or more and
are recorded at adjusted cost as a long-term investment. The
unrestricted shares and shares where the restrictions will lapse
in one year or less are recorded as a current asset and are
marked-to-market value through other comprehensive income as
required by SFAS 115.

At December 31, 2000, the market value of
the investment in UMC had declined to an amount significantly
below its original basis. It was determined at that point that
this decline was related to the downturn in the semiconductor
industry as a whole and was temporary in nature due to the
historically cyclical nature of the industry. During the first
half of 2001, the Company concluded that the downturn in the
semiconductor industry and the economy in general appeared to be
more severe than previously anticipated and that there was a
great deal of uncertainty regarding when the semiconductor
industry would recover from this down cycle. Because SONICblue
concluded that the decline in value of UMC was other than
temporary, it reported an unrealized loss on the UMC investment
of $468 million based on the market value at June 30,
2001. For the six months ended June 30, 2002, the Company
realized a gain of $5.1 million related to our sale of
23 million UMC shares.

As of June 30, 2002, SONICblues
105 million UMC shares were worth approximately
$126 million, based on the closing price of UMC shares on
the Taiwan Stock Exchange and the prevailing U.S. dollar to New
Taiwan Dollar exchange rate on that date. The Companys
available-for-sale portion of the investment will be
marked-to-market through other comprehensive income as required
by SFAS 115 for changes in market value subsequent to
June 30, 2002 unless a further decline in market value is
considered to be other than temporary. If any further decline is
considered to be other than temporary, the decrease in value of
both the available-for-sale and long-term portions of the
Companys UMC investment will be recorded as an expense in
the statement of operations.



| |                                     
| | ------------------------------------
| | Gain (Loss) on Other
    Investments

In the three months ended June 30, 2002, we
recognized a loss of $2.9 million primarily related to the
$9.4 million write-down of certain equity investments,
which were partially offset by the mark-to-market gain of
$6.4 million related to the liability associated with the
UMC options granted in conjunction with our financing and the
gains received from the sale of the final portion of our UMC
derivative instruments. In the three months ended June 30,
2001, we recognized a loss of $20.9 million primarily
related to the write down of certain equity investments. In the
six months ended June 30, 2002 and June 30, 2001, we
recognized a loss of

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$3.7 million and $21.6 million,
respectively, primarily related to the write-down of certain
equity investments. The downturn in the economy, particularly in
the high technology sector, contributed to the decline in the
market value of these securities. The remaining value of these
cost based equity investments totaled $6 million as of
June 30, 2002.




| |                 
| | ----------------
| | Interest Expense

Interest expense increased to $4.8 million
for the three months ended June 30, 2002 up from
$3.0 million for the three months ended June 30, 2001.
Interest expense increased to $6.6 million for the six
months ended June 30, 2002, up from $6.1 million for
the six months ended June 30, 2001. This increase is
primarily due to increased interest and the amortization of the
discount, issuance costs and equity instruments granted in
association with our recently issued senior subordinated
convertible debt. We expect to continue to incur significant
interest charges associated with our convertible subordinated
debt and, to a lesser extent, interest and fees associated with
our line of credit.



| |                            
| | ---------------------------
| | Other Income (Expense), Net

Other income was $0.4 million for the three
months ended June 30, 2002, compared to $1.1 million
for the three months ended June 30, 2001. Other income was
less than $0.1 million for the six months ended
June 30, 2002, compared to $1.1 million for the six
months ended June 30, 2001. The decrease in other income
was due primarily to lower foreign exchange losses.



| |             
| | ------------
| | Income Taxes

Our effective tax rate for the three months ended
June 30, 2002 and 2001 was 0.0% and 7.3%, respectively. Our
effective tax rate for the six months ended June 30, 2002
and 2001 was 0.0% and 24.8%, respectively. The effective tax
rate reflects expected tax payments on the adjusted taxable
income at the federal, state and international statutory rates.
Due to uncertainty associated with our prospective ability to
realize the benefits of our tax assets, we have fully reserved
the value of our deferred tax assets and do not expect to record
any tax benefit associated with any further operating losses
during the remainder of fiscal 2002.

Liquidity and Capital Resources

Cash used for operating activities was
$64.2 million for the six months ended June 30, 2002,
and consisted primarily of our net loss of $40.0 million
and working capital outlays associated with our growth in
revenues and the payment of certain outstanding liabilities.
Cash used for operating activities was $105.1 million for
the six months ended June 30, 2001, and consisted primarily
of our net loss of $648.3 million, which included a
non-operating loss on our UMC investment of $540.4 million,
deferred income taxes of $214.5 million and charges related
to the impairment of long-term assets of $109.1 million.

Investing activities provided cash of
$37.0 million for the six months ended June 30, 2002,
and consisted primarily of sales and maturities of short-term
investments including $38.9 million received from the sale
of 23 million UMC shares on the Taiwan Stock Exchange, and
the sale of all of our remaining UMC derivatives. Investing
activities provided cash of $93.4 million for the six
months ended June 30, 2001, and consisted primarily of
sales and maturities of short-term investments including cash
received from the sale of 73 million UMC shares on the
Taiwan Stock Exchange of $120 million, offset by notes
receivable of $30.1 million relating to the acquisition of
ReplayTV and Sensory Science.

Financing activities provided cash of
$60.3 million for the six months ended June 30, 2002,
and consisted primarily of the net proceeds from the private
placement of our senior subordinated convertible debentures.
Financing activities used cash of $16.5 million for the six
months ended June 30, 2001, and consisted of repayments of
notes payable offset by sales of common stock.

We had working capital of $29.5 million at
June 30, 2002. This working capital is primarily
attributable to the net proceeds received from the sale of our
$75 million senior subordinated convertible debentures, offset by

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the significant degradation in the value of our
available-for-sale UMC holdings and our continued operating
losses. We funded our 2002 and 2001 operating losses and
investment activities primarily through the sale of a portion of
our holdings in UMC.


A portion of the UMC shares received by SONICblue
are subject to restrictions on their sale that lapse over a
three-year period. At June 30, 2002, approximately
50 million shares were subject to restrictions that will
lapse in more than one year and are recorded at adjusted cost as
a long-term investment. Shares where the restrictions will lapse
in one year or less are recorded as a current asset and are
marked-to-market value through other comprehensive income.

Sensory Science has loans under a line of credit
with Congress Financial Corporation, which has a maturity date
of March 25, 2003. The maximum line of credit is
$25.0 million with a borrowing limit of $22.5 million,
limited by a borrowing base determined by specific inventory and
receivable balances of Sensory Science and an availability block
of $5.0 million. The line of credit is collateralized by
assets of Sensory Science and by a guarantee of SONICblue. In
addition, SONICblue is required to either hold unencumbered
shares of UMC stock with a market value of at least
$40 million or deliver to the lender an irrevocable standby
letter of credit with a face amount of at least $10 million.

During 2001, we sold a portion of our UMC
holdings, aggregating approximately 38.9 million shares, in
a derivative transaction. In connection with the sales of these
UMC holdings, we purchased a series of call option collars on
UMC stock with an aggregate notional amount of 38.9 million
shares. These transactions provided us funds from the sale of
the shares while allowing us to participate in future increases
in the value of UMC shares, if any, through this series of call
option collars. All such derivatives were sold in the first six
months of 2002.

In April 2002, we completed a private placement
of $75.0 million in aggregate principal amount of our
7 3/4% secured senior subordinated convertible debentures
due 2005 to three institutional investors. We also issued
warrants to purchase up to 7,500,000 shares of our common
stock to the investors, and a warrant to purchase
293,805 shares of our common stock to the placement agent
for the transaction. The private placement resulted in gross
proceeds to us, prior to the exercise of the warrants, of
approximately $62.3 million. The sale of the debentures and
the warrants closed on April 22, 2002. The debentures are
convertible into SONICblue common stock at a conversion price of
$19.22 per share subject to standard anti-dilution adjustments.
The warrants are fully vested and exercisable at any time until
April 22, 2007 at an exercise price of $3.39 per share
subject to standard anti-dilution adjustments. Under the terms
of the debentures we may pay up to 50% of the interest payments
on the debentures in shares of our common stock. Our repayment
obligation on the debentures is secured by a pledge of
21,426,586 shares of UMC stock. The institutional
investors also have an option to purchase these UMC shares from
us at an exercise price of $1.78 per share. We expect to
use the net proceeds from the private placement for working
capital and general corporate purposes.

We have incurred significant losses and expect
such losses to continue for at least the next six months. Our
net loss for the six months ended June 30, 2002 was
$40.0 million and for the year ended December 31, 2001
was $756.2 million. As of June 30, 2002, we have an
accumulated deficit of $527.6 million and cash, cash
equivalents, and short-term investments of $113.1 million.
We expect to experience negative cash flow from operations for
at least the next six months and believe that sufficient funds
will be available to support planned operations through the next
twelve months. Our future cash requirements will depend on a
number of factors including:



| |   |                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------
| |  | the rate at which customers accept and purchase
    our existing and future products;                                                  
|
| |  | the rate at which we invest in engineering,
    development and intellectual property with respect to existing
    and future products;
|
| |  | the level of marketing required to acquire a
    competitive position in the marketplace;                                              
|
| |  | our ability to reduce costs by negotiating with
    vendors for more favorable pricing;                                                
|
| |  | the operational costs that we incur to continue
    to develop our business as a whole;                                                

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| |   |                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------
| |  | our ability to sell our UMC shares, when needed,
    and at reasonable prices;                       
|
| |  | receipt, in August 2002, of the declared stock
    dividend of 15 million UMC shares;                
|
| |  | use of financial instruments to allow us to
    monetize our long-term UMC share holdings;           
|
| |  | the forbearance of the creditors of our legacy
    businesses to accept extended payment terms; and  
|
| |  | pending litigation as discussed in
    Part II  OTHER INFORMATION 
    Item 1. Legal Proceedings.

We may wish to selectively pursue possible
acquisitions of, or investments in businesses, technologies or
products complementary to ours in order to expand our geographic
presence, broaden our product offerings, and achieve operating
efficiencies. We may not have sufficient liquidity, or we may be
unable to obtain additional financing on favorable terms or at
all, in order to finance such an acquisition or investment.

An adverse business or legal development may
require us to raise additional financing. We recognize that we
may be required to raise such additional capital, at times and
in amounts, which are uncertain, especially under the current
capital market conditions. If we are unable to acquire
additional capital or are required to raise it on terms that are
less satisfactory than we desire, it may have a material adverse
effect on our financial condition, which could require
curtailing our operations significantly or to seek arrangements
with strategic partners or other parties that may require us to
relinquish significant rights to products, technologies or
markets. The Company is currently a party to certain legal
proceedings. Litigation could result in substantial expense to
the Company. See Part II  OTHER
INFORMATION  Item 1. Legal Proceedings.

Factors That May Affect Our Results



| |                                                                                                                                                                                                                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because SONICblues largest financial
    asset is its shares of United Microelectronics Corporation, the
    volatility of SONICblue common stock and available cash may be
    influenced by the volatility of UMCs stock price.
    SONICblues ability to sell its UMC shares is subject to
    lockup and pledge restrictions.

SONICblues largest financial asset is its
UMC shares. The market price of UMCs stock is subject to
volatility due to general market conditions as well as actual or
anticipated changes in UMCs business prospects or
quarterly or yearly operating results. Because the UMC shares
are SONICblues largest asset, when the price per share of
UMCs stock increases or declines, the price of
SONICblues common stock on the Nasdaq National Market
tends to follow changes in UMCs stock price. Fluctuations
in the price of SONICblue common stock caused by changes in
UMCs stock price may or may not reflect SONICblues
actual or anticipated business prospects or quarterly results.
Also, fluctuations in UMCs stock price may cause
fluctuations in SONICblues stock price when there is no
material news regarding SONICblue or any change in its results.

In addition, due to Taiwan governmental
restrictions, as of June 30, 2002, approximately
100 million of SONICblues UMC shares are subject to
lockup restrictions, which are being released over a three-year
period ending in January 2004. As a result, SONICblues
ability to sell its UMC shares is limited.

SONICblues repayment obligation on its
7 3/4% secured senior subordinated convertible debentures
due 2005 is secured by a pledge of 21,426,586 of its UMC shares.
The institutional investors that purchased the debentures also
have an option to purchase these UMC shares from SONICblue. In
addition, pursuant to a loan covenant, SONICblue must certify
each month that a portion of its UMC shares with a value equal
to at least $40.0 million is free of all liens, claims and
encumbrances. However, in lieu of making the certification,
SONICblue may deliver to the lender an irrevocable standby
letter of credit in the amount of $10.0 million.



| |                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------
| | SONICblue experienced net operating losses
    in the past and may experience net operating losses again in the
    future.

SONICblue had a net loss of $40.0 million
for the first half of 2002 and $756.2 million for the year
ended December 31, 2001, primarily resulting from the
recognition of a loss of $561.6 million related to the
decline in value of its UMC shares. SONICblue had net income of
$312.8 million for the year ended December 31, 2000,
primarily from recognizing a gain of $869.4 million on the
UMC shares but not as a result of income

23



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from operations. SONICblue had a net loss of
$30.8 million for 1999. With the completion of the transfer
of SONICblues graphics chips business, SONICblues
ability to achieve operating profitability depends primarily on
its success in refocusing its business resources and in
executing its business plan for its refocused business. In
addition, SONICblue must achieve positive gross margins at a
level sufficient to offset its operating expenses.
SONICblues ability to maintain or increase positive gross
margins is dependent upon SONICblues success in
negotiating lower prices with its vendors. SONICblue experienced
negative gross margins in 2000 and in the first six months of
2001 and there can be no assurance that it will not experience
negative gross margins in some future period. SONICblue cannot
assure you that it will be able to maintain the positive gross
margins it achieved in the last four quarters, nor can SONICblue
assure you that it will be able to achieve operating
profitability. If SONICblue is unable to achieve operating
profitability or incurs future losses and negative cash flow,
its stock price would likely decline, and additional financing
and restructuring activities would be required.




| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may not be able to maintain our listing
    on The Nasdaq National Market and if we fail to do so, the price
    and liquidity of our common stock may decline.

The Nasdaq Stock Market has quantitative
maintenance criteria for the continued listing of common stock
on The Nasdaq National Market. The current requirements
affecting us include (i) having net tangible assets of at
least $4 million and (ii) maintaining a minimum
closing bid of $1.00 per share. As of June 30, 2002, we
were in compliance with all Nasdaq National Market listing
requirements. However, there have been periods in the third
quarter of 2002 when the closing bid price per share for our
common stock was below $1.00. For example, on August 12,
2002, the closing bid price of our common stock was $0.37 per
share. If the closing bid price of our common stock price
remains below $1.00 per share for 30 consecutive days, our
common stock may not remain listed on the Nasdaq National
Market. Also effective November 1, 2002, we will need to
comply with The Nasdaq National Markets revised
quantitative maintenance criteria including a new minimum
requirement of $10.0 million in stockholders equity.
There can be no assurance that we will be able to comply with
the quantitative maintenance criteria or any of the Nasdaq
National Markets rules in the future. If we fail to
maintain continued listing on The Nasdaq National Market and
must move to a market with less liquidity, our financial
condition could be harmed and our stock price would likely
decline. If we are delisted, it could have a material adverse
effect on the market price of, and the liquidity of the trading
market for, our common stock.



| |                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue has recently changed the focus of
    its business and may be unsuccessful or experience difficulties
    in implementing this change. If this occurs, SONICblue may not
    be able to achieve operating profitability.

In January 2001, SONICblue completed the transfer
of its graphics chips business to S3 Graphics Co., Ltd., a joint
venture between VIA Technologies, Inc. and a wholly owned
subsidiary of SONICblue. Concurrently, SONICblue realigned its
resources to focus on the converging Internet, digital media,
entertainment and consumer electronics markets. To that end,
SONICblue recently completed acquisitions of Sensory Science
Corporation and ReplayTV, Inc., both of which are in the
consumer electronics and digital media industries. SONICblue has
a limited operating history with these markets, and its shift in
focus may prove to be unsuccessful. In connection with this
shift in focus, it may be necessary to implement new business
processes and internal controls. In addition, the convergence of
these industries is new and continually evolving. SONICblue must
compete with larger, more established competitors in these
markets, and SONICblue may be unable to achieve market success.
SONICblues profitability depends on its ability to
successfully implement its new business strategy.



| |                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue develops audio products for a new
    market, which may not develop if consumers do not accept digital
    audio as their preferred method of listening to music.
    Similarly, the market for ReplayTV digital video recorders may
    not develop if consumers do not accept personal
    television.

The market for digital audio products is new and
evolving. SONICblues digital audio products play music
that consumers download from the Internet or CDs. The success of
SONICblues digital audio products

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depends in part on consumers using the Internet,
rather than using solely traditional sources, such as record
stores where they buy CDs or cassette tapes, as a source of
music. If consumers do not access music on the Internet, or from
their CDs, and download it for use on SONICblues digital
audio products, a market for SONICblues digital audio
products may not develop or may be limited. ReplayTV digital
video recorders are part of a new and largely untested market
for personal television. If television viewers do not accept and
demand ReplayTV products and services, the market for ReplayTV
products will be limited.




| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | A reduction in the availability or ease of
    downloading music from the Internet will hurt the sales of
    SONICblues products.

SONICblues digital audio products play
music downloaded from the Internet and CDs. Currently, a variety
of litigation is pending that could decrease the availability of
downloadable music available on the Internet. The lawsuits
maintain that the swapping of music between different users free
of charge is a violation of the copyright laws in the United
States. If the record companies prevail in the litigation, and
companies offering similar services are forced to limit the
selection of music available for download or are forced to go
out of business, there would be a reduction in the amount of
music available to consumers on the Internet. For example,
Napster.com, an Internet service that allowed its users to swap
songs free of charge, was subject to an injunction that ordered
Napster to prevent users from trading copyrighted songs on its
web site. Napster subsequently filed for bankruptcy and its
future is uncertain. Members of the music and film industries
have filed lawsuits against other web sites that offer file
transfer services similar to those previously offered by Napster.

Some web sites and record companies are working
to provide fee-based downloading of copyright-protected music
files. If these web sites are unsuccessful in providing
copyright-protected music files or if consumers find the
downloading too difficult or expensive, acceptance of the
Internet as a source of music would decline. In addition, the
rate at which the major record companies make their music
available for digital purchases may discourage the use of
digital audio players or reduce SONICblues sales. Some
record companies and Internet companies are distributing, or
have announced plans to create, CDs or digital music that cannot
be copied or can only be copied a limited number of times, which
would also limit the ability of users to download music from
their own CD collections or share their music with others. New
copyright protection measures, such as these, increased fees
associated with making multiple copies of music from personal
collections, or changes in copyright laws, could diminish the
ability of consumers to download music to SONICblues
digital audio products. Reductions in the availability or ease
of downloading music from the Internet, or limitations on
copying from personal CDs, could also impair the use and sale of
SONICblues digital audio products.



| |                                                                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue historically has had significant
    product concentration and currently depends on the health of the
    consumer electronics market. This means that a decline in demand
    for a single product, or in the consumer electronics market in
    general, could severely affect SONICblues overall revenues
    and financial results.

SONICblues revenues have historically been
dependent on the markets for graphics/video chips for PCs and on
its ability to compete in those markets. With the completion of
the transfer of the graphics chips assets to a joint venture
between VIA and a wholly owned subsidiary of SONICblue,
SONICblues remaining businesses continue to have
significant product concentration. SONICblue is dependent on the
markets for digital audio players, digital and analog video
products, modems, and other consumer electronics products.
SONICblues business would be materially harmed if it were
unsuccessful in selling digital audio players, including its Rio
players, its Go-Video VCRs and DVD players or its ReplayTV
digital video recorders. A decline in demand or average selling
prices for these products would have a material adverse effect
on SONICblues sales and operating results.



| |                                                                                                              
| | -------------------------------------------------------------------------------------------------------------
| | SONICblues business is dependent on
    the Internet and the development of the Internet
    infrastructure.

The acceptance and sale of SONICblues
products could decrease if the infrastructure of the Internet,
particularly the development of broadband Internet access, does
not continue to be developed and maintained.

25



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For example, if consumers do not have the
necessary speed and data capacity for downloading music,
rendering the Internet too slow of a method for obtaining music,
consumers may choose not to download music, which will decrease
demand for SONICblues digital audio products. Similarly,
SONICblues ReplayTV 4000 digital video recorders rely or
will rely on high-speed access to the Internet to provide
compelling content or, to access television programming
information and send recorded programs to friends. In addition,
SONICblues success will depend in large part on increased
use of the Internet, which in turn can increase demand for
high-speed communications products and the products that benefit
from high-speed connections. SONICblues success will also
depend on businesses and consumers using the Internet more
frequently for applications that use multimedia content and that
require high bandwidth. Recent growth in Internet use has caused
frequent periods of performance degradation. Any perceived
degradation in the performance of the Internet as a whole could
undermine the benefits of SONICblues connectivity and
digital media products, such as Rio digital audio players and
ReplayTV 4000 products. The performance of SONICblues
products depends on the speed and reliability of the Internet
infrastructure itself. As a result, the emergence and growth of
the market for SONICblues products will depend on
improvements being made to the entire Internet infrastructure.




| |                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------
| | The joint venture with VIA will require
    SONICblue to pay specified liquidated damages if certain events
    occur.

The investment agreement between SONICblue, VIA
and S3 Graphics provides that under certain circumstances,
SONICblue may be required to pay VIA significant liquidated
damages if, unless as a result of certain acts or omissions on
the part of either VIA or S3 Graphics, S3 Graphics is prevented
by court order from utilizing SONICblues patent
cross-license with Intel Corporation or if SONICblue enters into
a settlement agreement with Intel such that S3 Graphics can no
longer operate under the patent cross-license. In September
2001, Intel filed a patent infringement lawsuit against S3
Graphics and VIA. SONICblue is not a party to the lawsuit. The
lawsuit is in early stages. Any liquidated damages that
SONICblue might be required to pay to VIA under the investment
agreement may under certain circumstances be reduced by amounts
paid by SONICblue to Intel in connection with any lawsuit and
amounts owed to SONICblue by either VIA or S3 Graphics. An
adverse result or settlement with regard to these proceedings
could have a material adverse effect on SONICblues
financial condition or results of operations.



| |                                                                                               
| | ----------------------------------------------------------------------------------------------
| | SONICblue may not be able to successfully
    manage the growth and expansion of its business.

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



| |   |                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | attracting, integrating and retaining key
    employees;                                                                                              
|
| |  | integration of management information, product
    data management, internal control, accounting,
    telecommunications and networking systems;      
|
| |  | establishment of a significant worldwide web and
    e-commerce presence;                                                                             
|
| |  | consolidation of geographically dispersed
    manufacturing and distribution facilities;                                                              
|
| |  | coordination of suppliers, rationalization of
    distribution channels, establishment and documentation of
    business processes and procedures; and
|
| |  | integration of various functions and groups of
    employees.                                                                                         

SONICblue may not successfully address these
challenges. SONICblues future operating results will
depend in large measure on its ability to implement operating,
manufacturing and financial procedures and controls that not
only address the expansion of its operations but also the change
in focus of its business from

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graphics chips and boards to consumer electronic
products, improve communication and coordination among the
different operating functions, integrate functions such as
sales, procurement and operations, strengthen management
information and telecommunications systems, and continue to hire
additional qualified personnel in key areas. SONICblue may be
unable to manage these activities and implement these additional
procedures, controls and systems successfully. Any failure to do
so could cause SONICblues short-term and long-term
operating results to suffer.




| |                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblues quarterly and annual
    operating results are subject to fluctuations caused by many
    factors, any of which could result in SONICblues failure
    to achieve its revenue or profitability
    expectations.

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



| |   |                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | SONICblues ability to develop, introduce,
    produce in volume quantities and market successfully new or
    enhanced products;                                                                                                              
|
| |  | SONICblues ability to introduce and market
    products in accordance with market demand and short design
    cycles;                                                                                                                         
|
| |  | changes in the relative volume of sales of
    various products with sometimes significantly different margins;                                                                                                                                
|
| |  | market acceptance of and changes in demand for
    SONICblues products;                                                                                                                                                                       
|
| |  | rapid changes in electronic commerce on which
    SONICblue or its customers may not capitalize or which erode
    SONICblues current business base;                                                                                          
|
| |  | gains or losses of significant customers,
    distributors or strategic relationships;                                                                                                                                                         
|
| |  | unpredictable volume and timing of customer
    orders;                                                                                                                                                                                        
|
| |  | the availability, pricing and timeliness of
    delivery of components for SONICblues products, including
    flash memory;                                                                                                                   
|
| |  | substantial disruption in SONICblues
    suppliers operations, either as a result of natural
    disaster, equipment failure or other cause;                                                                                                 
|
| |  | fluctuations in the availability of manufacturing
    capacity or manufacturing yields and related manufacturing costs;                                                                                                                        
|
| |  | the timing of new technological advances, product
    announcements or introductions by SONICblue or by its
    competitors;                                                                                                                   
|
| |  | product obsolescence and the management of
    product transitions and inventory;                                                                                                                                                              
|
| |  | production delays;                                                                                                                                                                                                                             
|
| |  | decreases in the average selling prices of
    products;                                                                                                                                                                                       
|
| |  | rates of product return in excess of those
    forecasted or expected;                                                                                                                                                                         
|
| |  | seasonal fluctuations in sales;                                                                                                                                                                                                                
|
| |  | general consumer electronics industry conditions,
    including changes in demand and associated effects on inventory
    and inventory practices; and                                                                                         
|
| |  | general economic conditions, including economic
    conditions in North America, Europe and Asia in particular, that
    could affect the timing of customer orders and capital spending
    and result in order cancellations or rescheduling.

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Some or all of these factors could adversely
affect demand for SONICblues products and its future
operating results. Most of SONICblues operating expenses
are relatively fixed in the short-term. SONICblue may be unable
to rapidly adjust spending to compensate for any unexpected
sales shortfall, which could harm its quarterly operating
results. Because the lead times of firm orders are typically
short in the consumer products industry, SONICblue does not have
the ability to predict future operating results with any
certainty. Because of the above factors, you should not rely on
period-to-period comparisons of results of operations as an
indication of future performance.



| |                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------
| | The demand for SONICblues products
    has historically been weaker in certain quarters, which makes it
    difficult to compare its quarterly results.

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



| |   |                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a greater proportion of SONICblues sales
    consist of sales into the retail/mass merchant channel;                                                                                                                                                                
|
| |  | SONICblues net revenues become increasingly
    based on entertainment-related products, including products such
    as its Rio digital audio players, Sensory Science dual-deck VCRs
    and combination DVD/VCR units and ReplayTV digital video
    recorders; or
|
| |  | to the extent SONICblue expands its European
    sales, it may experience relatively weak demand in the third
    calendar quarter due to historically weak summer sales in Europe.                                                                                  

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



| |                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | General economic conditions and political
    and military conditions associated with current worldwide
    conflicts and similar events may prevent consumers from
    purchasing SONICblues products, which would harm its
    revenues.

Sales of consumer electronic products have
historically been dependent upon discretionary spending by
consumers, which may be adversely affected by general economic
conditions. The slowdown in the United States economy may cause
consumers to defer decisions to purchase SONICblues
products. Some analysts have predicted a further decline in the
United States economy will result from recent volatility in the
financial markets. If the economy continues to decline as a
result of recent economic, political and social turmoil,
consumers may reduce discretionary spending and may not purchase
SONICblues products.



| |                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The markets in which SONICblue operates are
    intensely and increasingly competitive, and if it is unable to
    compete successfully, its revenues could decline.

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



| |   |                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------
| |  | performance and quality;                                                                                              
|
| |  | ability to conform and adapt to, or upgrade for,
    current and evolving industry standards, including audio formats;
|
| |  | access to customers and distribution channels;                                                                        

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| |   |                                                                    
| | - | -------------------------------------------------------------------
| |  | reputation for quality and strength of brand;                      
|
| |  | manufacturing capabilities and cost of
    manufacturing;          
|
| |  | price;                                                             
|
| |  | product support; and                                               
|
| |  | ability to bring new products to the market in a
    timely manner.

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

In some markets where SONICblue is a relatively
new entrant, including digital audio or Internet music players
and digital video products, it faces dominant competitors that
include Apple (digital audio players), 3Com (modems), Creative
Technology under the name Creative Labs (modems and digital
audio players), Handspring (digital audio player add-ons to
PDAs), Gateway (home network digital audio players), HP (home
digital audio players and digital audio players), Kenwood (home
digital audio players), Microsoft (digital video recorders),
Motorola (handheld consumer electronics), Panasonic (digital
audio players, digital video recorders and combination
TV/DVD/VCR players), Philips (digital audio players, home
digital audio players, digital video recorders and home
theater-in-a-box solutions), Pioneer (home theater-in-a-box
solutions), RCA (digital video recorders), Samsung (digital
audio players, digital audio player mobile telephones and
combination DVD/VCR players), Sony (home theater-in-a-box
solutions, consumer electronic music, digital audio players and
digital video recorders), Thompson Multimedia (digital audio
players), TDK (CD MP3 players) and TiVo (digital video
recorders). Some of SONICblues products face a variety of
competitive sources. For example, digital audio players compete
against traditional stereos and CD players. In addition, the
markets in which SONICblue competes are expected to become
increasingly competitive as PC products support increasingly
more robust multimedia functions and companies that previously
supplied products providing distinct functions (for example,
companies today primarily in the sound, modem, microprocessor or
motherboard markets) emerge as competitors across broader or
more integrated product categories.



| |                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue operates in markets that are
    highly cyclical and vulnerable to sharp declines in demand and
    average selling prices.

SONICblue operates in the digital media and
consumer electronics markets. These markets have in the past
experienced, and may in the future experience, significant
downturns. In the event of an extensive downturn, SONICblue
would likely experience significantly reduced demand for its
products and may be pressured to reduce average selling prices.
During the second quarter of 2002, SONICblue experienced price
pressure in the video product line, which resulted in lowered
average selling prices in order to retain market share. In the
near term, SONICblue expects to derive most of its revenues from
the sale of digital audio products, such as Rio players, and
video products, such as Go-Video dual-deck VCRs and combination
DVD/VCR units and ReplayTV digital video recorders. Changes in
demand in digital media and consumer electronics markets could
be large and sudden. Since retailers often build inventories
during periods of anticipated growth, they may be left with
excess inventories if market growth slows or if they have
incorrectly forecasted product transitions. In these cases, the
retailers may abruptly stop purchasing additional inventory from
suppliers like SONICblue until the excess inventory has been
used. This suspension of purchases or any reduction in demand
for SONICblues products would negatively impact its
revenues and financial results. SONICblue may experience
substantial period-to-period fluctuations in results of
operations due to these general industry conditions.

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| |                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If SONICblue is unable to continue to
    develop and market new and enhanced products, its average
    selling prices and gross margins will likely
    decline.

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



| |                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If SONICblue fails to identify new product
    opportunities or develop and market new and enhanced products,
    it will not be able to compete successfully.

The markets for which SONICblues products
are designed are intensely competitive and are characterized by
rapidly changing technology, evolving industry standards and
short product life cycles. For example, the life cycles of the
Rio audio players typically range from 9 to 12 months. If
SONICblue fails to introduce new products successfully within a
given time frame, SONICblue could lose revenues and market
share. Further, continued failure to develop, introduce and
market competitive new products that meet customer demands on
time could also damage SONICblues brand name, reputation
and relationships with its customers and cause longer-term harm
to its financial condition. SONICblue may not successfully enter
the various product markets that it identifies. In addition, the
sale of new products may not become significant or profitable.
To succeed in this environment, SONICblue must anticipate the
features and functionality that customers will demand. SONICblue
must then incorporate those features and functionality into
products that meet the design, performance, quality and pricing
requirements of the digital media and consumer electronics
markets in which it competes and the timing requirements of
retail selling seasons. SONICblue believes this will require
continued significant expenditures for research and development
activities. SONICblue has in the past experienced delays in
completing the development and introduction of new products and
may experience similar delays in the future. In the past,
SONICblues business was seriously harmed when it developed
products that failed to achieve significant market acceptance,
and, therefore, was unable to compete successfully in its
markets. This type of failure could occur again in the future.



| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | SONICblue must manage product transitions
    successfully in order to remain competitive.

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



| |                                                                                                                                                                                                                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue depends on a limited number of
    suppliers from whom it does not have a guarantee of adequate
    supplies, increasing the risk that a loss of or problems with a
    single supplier could result in impaired margins, reduced
    production volumes, strained customer relations and loss of
    business.

SONICblue obtains several of the components used
in its products, including flash memory for its Rio players and
semiconductors, hard drives, program guide data and set-top box
compatibility information for its

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ReplayTV digital video recorders and service from
single or limited sources. If component manufacturers do not
allocate a sufficient supply of components to meet its needs or
if current suppliers do not provide components of adequate
quality or compatibility, SONICblue may have to obtain these
components from distributors or on the spot market at a higher
cost. SONICblue rarely has guaranteed supply arrangements with
its suppliers, and suppliers may not be able to meet its current
or future component requirements. If SONICblue is forced to use
alternative suppliers of components, it may have to alter its
product designs to accommodate these components. Alteration of
product designs to use alternative components could cause
significant delays and reduce its production of the related
products. In addition, from time to time, SONICblue has
experienced difficulty meeting certain product shipment dates to
customers for various reasons. These reasons include component
delivery delays, component shortages and component quality
deficiencies. Delays in the delivery of components, component
shortages and supplier product quality deficiencies will likely
continue to occur in the future. These delays or problems have
in the past and could in the future result in impaired margins,
reduced production volumes, strained customer relations and loss
of business.


Also, in an effort to avoid actual or perceived
component shortages, SONICblue may purchase more of certain
components than it may otherwise require. Excess inventory
resulting from over-purchases, obsolescence or a decline in the
market value of such inventory could result in inventory
write-offs, which would have a negative effect on
SONICblues financial results.



| |                                                                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If SONICblue is unable to predict market
    demand for its individual products, and focus its inventories
    and development efforts to meet market demand, it could lose
    sales opportunities and experience declines in
    revenues.

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



| |                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Demand for SONICblues digital audio
    and video products may decrease if the same capabilities
    provided by its products become available in or as add-ons to
    other personal electronics products.

A substantial portion of SONICblues net
sales in 2001 was derived from the sale of digital audio
players. There is a trend within the personal electronics
industry for functionality from individual products to be
integrated with other personal electronics products. For
example, Samsung, Fuji, Handspring and others have developed or
announced plans to develop personal electronic products, such as
mobile telephones, digital cameras or PDA plug-ins that
integrate digital audio functions, and in the digital video
market, Panasonic offers combination TV/DVD/VCR players,
DirectTV offers satellite receiver set-top boxes with TiVo
software installed, and Sony and Creative Labs have announced
hardware and software products that would give PCs some DVR
functionality. These products could significantly reduce the
demand for SONICblues products. As a result of these
trends of technology migration and product integration,
SONICblues success largely depends on its ability to
continue to develop products that incorporate new and rapidly
evolving technologies into its products.

SONICblue must continue to expand the scope of
its research and development efforts to provide the latest in
digital audio and video technology products, which will require
that it hire and retain engineers skilled in these areas and
promote additional coordination among its design and engineering
groups. Alternatively, SONICblue may find it necessary or
desirable to license or acquire technology to enable it to
provide these

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functions. This technology may not be available
for license or purchase on terms acceptable to SONICblue, if at
all.




| |                                                                            
| | ---------------------------------------------------------------------------
| | SONICblue depends on third parties for the
    manufacture of its products.

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

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



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblues products could have
    defects or compatibility issues, which could be costly to
    correct and could result in the rejection of its products and
    damage to its reputation, as well as lost revenues, diverted
    development resources and increased service costs and warranty
    claims.

SONICblues products could have design
defects that could cause them to malfunction. Product components
may contain undetected errors or bugs when first
supplied to SONICblue that, despite testing by SONICblue, are
discovered only after SONICblues products have been
installed and used by customers. From time to time, SONICblue
has become aware of problems with components, product designs
and other defects. Errors or defects in SONICblues
products may arise in the future, and, if significant or
perceived to be significant, could result in rejection of
SONICblues products, product returns or recalls, damage to
SONICblues reputation, lost revenues, diverted development
resources and increased customer service and support costs and
warranty claims. Errors or defects in SONICblues products
could also result in product liability claims. SONICblue
includes, or bundles, internally developed and third party
software, including operating systems, with its hardware
products. For example, the software included in its ReplayTV
digital video recorders is responsible for the products
user interface and directs certain product functions. Also,
SONICblue includes software with its Rio players that the
purchaser may use to download and store MP3 or WMA files on the
player. The software products and SONICblues hardware
products are complex and may contain undetected errors or
failures when first introduced or as new versions are released.
SONICblue has distributed updates to Rio players in the past
when required to improve sound quality or to correct minor audio
problems and to its ReplayTV digital video recorders to improve
functionality. SONICblue generally provides warranties for its
retail products allowing the return or repair of defective
products. Despite testing by SONICblue, its suppliers or current
or potential customers, errors may be found in new products
after commencement of commercial shipments. These errors could
result in loss of or delay in market acceptance or product
acceptance or in warranty returns. Losses, delays or damage to
SONICblues reputation due to product defects would likely
harm SONICblues business, financial condition and results
of operations.

Additionally, new versions or upgrades to
operating systems, independent software vendor titles or
applications may require upgrades to the personal computer
software products SONICblue bundles with its

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




| |                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------
| | SONICblue is subject to risks relating to
    product returns and price protection, which could limit
    SONICblues revenues.

SONICblue often grants limited rights to
customers and distributors to return unsold inventories of its
products in exchange for new products, also known as stock
rotation. Also, some of SONICblues retail customers
may accept returned products from their own retail customers.
These products are then returned to SONICblue for credit.
SONICblue has in the past experienced a significant percentage
of returns of its Rio players. SONICblue estimates stock
rotation, warranty and other returns and accrues reserves for
such costs at the time of sale. SONICblue also often grants
price protection on unsold inventory, which allows customers to
receive a price adjustment on existing inventory when its
published price is reduced. In an environment of slower demand
and abundant supply of products, price declines and channel
promotional expenses are more likely to occur and, should they
occur, are more likely to have a significant impact on
SONICblues operating results. Further, in this
environment, high channel inventory levels may result in
substantial price protection charges. These price protection
charges have the effect of reducing gross sales and gross
margin. Consequently, in taking steps to bring its channel
inventory levels down to a more desirable level, SONICblue may
cause a shortfall in net sales during one or more accounting
periods. These efforts to reduce channel inventory might also
result in price protection charges if prices are decreased to
move product out to final consumers, having a further adverse
impact on operating results. Any estimates, reserves or accruals
may be insufficient and any future price reductions or product
returns may seriously harm its operating results.



| |                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue depends on sales through
    distributors and retailers. If relationships with or sales
    through distributors or retailers decline, its operating results
    will be harmed.

SONICblue sells its products through a network of
domestic and international distributors, and directly to major
retailers/mass merchants. SONICblues future success is
dependent on the continued viability and financial stability of
its customer base. Retail channels historically have been
characterized by rapid change, including periods of widespread
financial difficulties and consolidation and the emergence of
alternative sales channels, such as direct mail order, telephone
sales and electronic commerce on the worldwide web. SONICblue
may be unable to retain its retailers or distributors. In
addition, sales to any particular retailer or distributor may
fluctuate significantly from quarter to quarter. The loss of, or
a reduction in, sales to any of SONICblues key retail or
distribution customers as a result of changing market
conditions, competition or customer credit problems could
materially and adversely affect its operating results. Likewise,
changes in distribution channel patterns, such as increased
electronic commerce via the Internet and increased use of
mail-order catalogues, could affect SONICblue in ways not yet
known.



| |                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblues ability to market and
    distribute its products depends in part upon its current and
    future relationships with original equipment manufacturers, or
    OEMs, and other strategic partners to market and distribute
    SONICblues products under their own brand
    names.

In addition to direct distributors of
SONICblues products, SONICblue also depends upon OEMs and
other strategic partners to market and distribute its products.
For example, SONICblue has licensed the ReplayTV technology to
Panasonic, which has incorporated the technology into its
ShowStopper DVRs. If SONICblue is unable to obtain and maintain
relationships with OEMs and strategic partners, it may not be
able to increase sales of its products and achieve market
acceptance, and its revenues may decline.

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| |                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue relies on intellectual property
    and other proprietary information that may not be adequately
    protected and that may be expensive to protect.

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

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



| |                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue has recently made changes to its
    management and may be unsuccessful or experience difficulties in
    integrating the new management.

SONICblue has recently undergone changes in
several management positions, most recently appointing L.
Gregory Ballard as its Interim Chief Executive Officer. Prior to
his appointment, Mr. Ballard served as SONICblues
Vice President for Marketing and Product Management since April
2002. Other members of SONICblues management team are
relatively new to SONICblue, and there can be no assurance that
Mr. Ballard and the other executive officers of SONICblue
will be able to collaborate successfully. If the executive
officers are unable to collaborate successfully, the business,
financial condition and results of operations could suffer.



| |                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------
| | SONICblue may not be able to attract,
    retain or integrate key personnel, which may prevent it from
    succeeding.

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



| |                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue depends on a limited number of
    third party developers and publishers that develop software
    products that will operate with and fully utilize the
    capabilities of its Rio players.

Only a limited number of software developers are
producing software that enables the download and use of digital
audio players. SONICblue does not create the software that is
required to download or convert from CDs music to run on its
players but bundles third party software with its players. If
SONICblue is not able to

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license and bundle the software, or if users are
not otherwise able to obtain software free of charge or at an
acceptable price, then demand for SONICblues digital audio
players will decline. Likewise, difficult to use or defective
software could negatively impact SONICblues product sales
and revenues.




| |                                                     
| | ----------------------------------------------------
| | SONICblue has exposure to international
    markets.

International sales accounted for 5% and 50% of
SONICblues net sales for the six months ended
June 30, 2002, and 2001, respectively. In addition, a
substantial proportion of SONICblues products are
manufactured, assembled and tested by independent third parties
in Asia. As a result, SONICblue is subject to the risks of
conducting business internationally, including:



| |   |                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | unexpected changes in, or impositions of,
    legislative or regulatory requirements;                                                                                                                
|
| |  | fluctuations in the U.S. dollar, which could
    increase the price in local currencies of SONICblues
    products in foreign markets or increase the cost of components
    purchased by SONICblue;
|
| |  | delays resulting from difficulty in obtaining
    export licenses for certain technology;                                                                                                            
|
| |  | tariffs and other trade barriers and restrictions;                                                                                                                                                   
|
| |  | potentially longer payment cycles;                                                                                                                                                                   
|
| |  | greater difficulty in accounts receivable
    collection;                                                                                                                                            
|
| |  | potentially adverse tax treatment; and                                                                                                                                                               
|
| |  | the burdens of complying with a variety of
    foreign laws.                                                                                                                                         

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



| |                                                                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue has a significant level of debt,
    which may harm its ability to obtain additional financing or
    adversely affect its liquidity. If the Company is unable to
    generate or otherwise obtain sufficient funds, its financial
    condition and operations may be harmed.

At June 30, 2002, SONICblue had total debt
and other liabilities outstanding of $326.6 million.
Included in this debt is our $75.0 million in aggregate
principal amount of 7 3/4% secured senior subordinated
convertible debentures due 2005 that we sold in a private
placement in April 2002. The degree to which SONICblue is
leveraged could harm its ability to obtain additional financing
for working capital or other purposes and could make SONICblue
more vulnerable to economic downturns and competitive pressures.
SONICblues significant leverage could also adversely
affect its liquidity, as a substantial portion of available cash
from operations may have to be applied to meet debt service
requirements. In the event of a cash shortfall, SONICblue would
likely be forced to reduce other expenditures to be able to meet
such debt service requirements.

If SONICblue is unable to raise sufficient funds
for working capital needs, it may not be able to fund product
development and expansion, take advantage of future
opportunities, meet its existing debt obligations or respond to
competitive pressures or unanticipated events or needs.
SONICblue may also be required to curtail its operations
significantly or to seek arrangements with strategic partners or
other parties that may require SONICblue to relinquish
significant rights to products, technologies or markets.

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| |                                                                                    
| | -----------------------------------------------------------------------------------
| | Minority investments could adversely affect
    SONICblues liquidity and earnings.

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



| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | SONICblue may pursue strategic acquisitions
    and could fail to successfully integrate acquired
    businesses.

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



| |                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | System failures, interruptions to the
    ReplayTV service or product defects may have a negative impact
    on SONICblues revenues, damage its reputation and decrease
    its ability to attract new viewers.

SONICblues ability to provide high quality
products, service and customer support is critical to its
success because consumers of television-related products are not
accustomed to, and may not accept, interruptions in their
television service. SONICblues network, communications
hardware and other operating systems for the ReplayTV service
are vulnerable to damage or interruption from earthquakes,
floods, fires, power loss, telecommunication failures and
similar events. They are also subject to break-ins, sabotage,
intentional acts of vandalism and similar misconduct. These
types of interruptions in the ReplayTV service may reduce
SONICblues revenues and profits. In addition to placing
increased burdens on SONICblues engineering staff, service
outages will create numerous customer questions and complaints
that must be responded to by SONICblues or its
partners customer support personnel. Any frequent or
persistent system failures could irreparably damage
SONICblues reputation and brand.

In addition, any delivery by SONICblue of
products or upgrades with undetected material product defects or
software errors could harm SONICblues credibility. For
example, the hard disk used in the ReplayTV-enabled digital
video recorder was originally designed for use in personal
computers, and as a result exhibits behaviors that are viewed as
typical and minimally disruptive when using a personal computer,
but may result in the viewer momentarily facing a black
television screen when using the ReplayTV service. Any errors
and product defects can result in delays in releasing new
versions of ReplayTV digital video recorders, affect system
uptime, result in returns and significant warranty and repair
costs and cause customer relations problems. Correcting errors
in software and hardware design requires significant time and
resources, which could delay future product releases and affect
market acceptance of ReplayTV digital video recorders.



| |                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SONICblue needs to safeguard the security
    and privacy of ReplayTV viewers confidential data, and any
    inability to do so may harm SONICblues reputation and
    brand and could result in lawsuits.

The ReplayTV digital video recorder collects and
stores viewer preferences and other data that viewers may
consider confidential. Any compromise or breach of the
encryption and other security measures that SONICblue uses to
protect this data could harm SONICblues reputation and
expose it to potential liability. Advances in computer
capabilities, new discoveries in the field of cryptography or
other events or developments could compromise or breach the
systems SONICblue uses to protect its viewers confidential

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information. SONICblue may be required to make
significant expenditures to protect against security breaches or
to remedy problems caused by any breaches.


Viewers may be concerned about the use of
personal information gathered by the ReplayTV digital video
recorder. SONICblue does not currently archive this data or
release it to third parties, and SONICblue is committed to
complying with all privacy laws and to protecting the
confidentiality of its viewers. The motion picture studios and
television networks seek anonymous user data but privacy
concerns could create uncertainty in the marketplace for
personal television and ReplayTV products. In addition, privacy
concerns or breaches, or consumers dissatisfaction with
any privacy policy SONICblue may adopt, could reduce demand for
ReplayTV products, increase the cost of doing business as a
result of litigation costs or increased service delivery costs,
or otherwise harm SONICblues reputation and business.



| |                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | One of SONICblues recently announced
    products is the subject of a copyright infringement claim. If
    this or future claims against SONICblues products are
    decided against SONICblue, sales of SONICblues products
    and its revenues could decrease.

In October and November, 2001, a group of 28
entertainment companies including, among others, Paramount
Pictures Corporation, Disney Enterprises, Inc. and the three
major television networks filed four lawsuits against SONICblue
and its ReplayTV, Inc. subsidiary in the U.S. District Court in
Los Angeles, California. The lawsuits allege that the
Companys planned manufacture and sale of the
ReplayTV 4000, which allows users to skip commercials and
to use the Internet to send recorded material to other
ReplayTV 4000 users, constitutes copyright infringement,
among other claims. The plaintiffs in the lawsuits are seeking
an injunction prohibiting the Company from including these
features in its video products. Although one of the lawsuits
originally alleged that the Companys Go-Video VCRs
featuring the commercial skipping technology similarly violate
the copyright laws, in their amended complaint plaintiffs
eliminated these claims in November 2001. The parties have
commenced discovery. The District Court preliminarily scheduled
a consolidated trial in August 2002 but removed the trial from
its calendar in April 2002 and has not set a new trial date.
SONICblue intends to dispute the plaintiffs claims and
defend this action vigorously.

In June, 2002, a group of five individual
ReplayTV 4000 owners filed a lawsuit in the United States
District Court in Los Angeles against the 28 entertainment
companies described above, seeking a declaration that their use
of the ReplayTV 4000 device is fair use and does not
infringe copyrights. Those individuals named SONICblue and its
ReplayTV, Inc. subsidiary as nominal defendants, although those
individuals interests are substantially aligned with the
Companys position. This complaint does not demand any
affirmative relief against the Company, but purports to reserve
the right to amend to seek an injunction to prohibit the Company
from discontinuing support for features that were advertised or
served as inducements for consumers purchases, absent
restitution to such consumers.

Litigation may be costly and can divert the
efforts of management. Furthermore, SONICblue may be forced to
delay the release, or eliminate certain features of, its digital
video recorders, which could result in decreased sales of the
product and a negative impact on SONICblues revenues.

Sensory Science, acquired by SONICblue in June
2001, has designed and markets its dual-deck VCRs and
combination DVD/ VCRs for use as full-featured videocassette
recorders. The marketing literature and owner manuals caution
consumers that the dual-deck VCR should not be used in a manner
that infringes on the rights of owners of copyrighted material.
However, SONICblue cannot predict the likelihood that
distribution of current or future dual-deck VCRs or DVD/VCR
models will be challenged. Federal legislation affecting all
VCRs was passed in October 1998, commonly referred to as The
Digital Millennium Copyright Act. As a result, Sensory Science
modified the operations of its dual-deck VCRs sold after April
2000, so that the VCRs would recognize a type of anticopying
signal to prevent consumers from making a usable copy of
videotapes with that type of signal. However, models purchased
prior to April 2000 continued to operate as originally designed
for the lifetime of the VCR. SONICblue is unable to determine
what the effect of this or future required modifications may be
on future sales of dual-deck VCRs or combination DVD/VCRs.

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| |                                                                                                            
| | -----------------------------------------------------------------------------------------------------------
| | SONICblue is a party to legal proceedings
    that could have a negative financial impact on
    SONICblue.

SONICblue has also been defending several
putative class action lawsuits naming Diamond, which were filed
in June and July 1996 and June 1997 in the California Superior
Court for Santa Clara County and the U.S. District Court
for the Northern District of California. The plaintiffs alleged
that Diamond and the other defendants made various material
misrepresentations and omissions during the class period. The
parties have agreed to settle this matter for a payment of
$15.0 million, and final court approval of that settlement
was obtained, and the cases dismissed, in April 2002. SONICblue
funded $4.5 million of the settlement in November 2000.
SONICblue previously accrued this amount in connection with the
merger with Diamond. SONICblue believes that Diamonds
insurance covers the remaining $10.5 million of the
settlement; Diamonds insurers have funded that amount into
the settlement, although one of these insurers has commenced
arbitration disputing its obligation to pay $3.0 million of
the $10.5 million. The contesting insurer maintains that
indemnification of its share of the settlement is barred by
virtue of a recent California appellate decision. The
arbitration tribunal issued an order in April 2002, stating that
the California state law claim in the class action was
uninsurable, but that factual questions were presented as to the
allocation of the settlement amount as between the state law
claim and other claims included in the settlement documents.
Further proceedings are contemplated before the tribunal, but no
schedule has as yet been set.

In November 2001, four former holders of ReplayTV
preferred shares filed a petition for appraisal in the Chancery
Court in the State of Delaware asserting their dissenters rights
of appraisal and seeking the fair value of their ReplayTV shares
in cash in lieu of the SONICblue shares to be issued to them as
provided in SONICblues merger agreement with ReplayTV. In
December 2001, ReplayTV filed its response to plaintiffs
petition. In addition, in December 2001, the same four former
holders of ReplayTV preferred shares filed a complaint in the
Chancery Court in the State of Delaware asserting that ReplayTV
and its former directors breached their fiduciary duties in
connection with Replay TVs merger by engaging in
self-dealing, failing to make appropriate disclosures to
shareholders and failing to maximize the value for them in the
merger, resulting in an allocation of an insufficient amount of
the merger consideration to the ReplayTV preferred stockholders.
The complaint seeks at least $7,249,990.50 in
damages. In its merger agreement with ReplayTV, SONICblue agreed
to indemnify ReplayTVs former directors against this type
of lawsuit, among other things. In February 2002, ReplayTV and
the former ReplayTV directors filed their answer. SONICblue and
ReplayTV intend to dispute the plaintiffs claims and
vigorously defend these actions. The cases are currently in the
pretrial discovery stage.

On December 12, 2001, SONICblue filed a
complaint for patent infringement against TiVo, Inc. in the
United States District Court for the Northern District of
California. SONICblues complaint generally alleges that
TiVo is infringing one of its patents by licensing and offering
to license its DVR technology and offering its program guide
service. In response, TiVo filed an answer and counterclaim
against SONICblue that denies infringement of SONICblues
patent and that alleges that the patent is invalid. On
January 23, 2002, TiVo filed a separate action in the same
court, but assigned to a different judge, that generally alleges
that SONICblue is infringing one of TiVos patents by
making, selling, offering to sell its ReplayTV DVRs. The parties
have agreed to suspend further proceedings in the two cases
through Fall 2002 to facilitate settlement discussions between
them. If the cases do not settle, SONICblue intends to
vigorously defend itself against the allegations made in
TiVos complaint and counterclaim.

On November 28, 2001, Techsearch, LLC filed
a complaint for patent infringement against a number of consumer
electronics companies, including SONICblue, in the United States
District Court for the Northern District of Illinois.
Techsearchs complaint generally alleges that SONICblue is
infringing one of its patents by making, selling, and offering
to sell its Rio Volt CD players that are capable of playing CDs
encoded with audio tracks in the MP3 format. SONICblue intends
to dispute the plaintiffs claims and vigorously defend
itself against the allegations made in Techsearchs
complaint. This action was stayed by order of the Court on or
about May 1, 2002, pending a reexamination of the patent
asserted by Techsearch by the U.S. Patent and Trademark Office.

On February 14, 2000, Robert C. Price filed
a purported class action lawsuit in the Circuit Court of Monroe
County, State of Indiana against the Company and Diamond
alleging violations of the California

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Business and Professions Code section 17200
and the California Song-Beverly Act, which covers consumer
warranties. The lawsuit alleges that certain of the
Companys Rio 300 MP3 player retail boxes, which were
discontinued in approximately 1999, are misleading because the
boxes indicate that computer software included in the package
allows the purchaser to convert audio tracks on CDs to the MP3
audio format, but the software included with the product
permitted only 50 conversions. The Company answered the
complaint on April 27, 2000, denying plaintiffs
allegations. Status conferences were conducted on July 26,
2000, January 10, 2001, and April 17, 2002. Discovery
has commenced. No class has been certified, but the briefing on
the plaintiffs motion for class certification is expected
to be completed by Fall 2002, with a hearing on class
certification issues to be scheduled thereafter. SONICblue
intends to contest the certification of the purported class,
dispute the lawsuits allegations and defend this action
vigorously.


In November 2001, Pac Tec, a division of La
France Corporation, filed a civil action against the Company and
one of its suppliers, Manufacturers Services Limited, in
the United States District Court for the Eastern District of
Pennsylvania, alleging claims against both defendants jointly
for breach of contract and promissory estoppel. The plaintiff
seeks damages in excess of $2.5 million, plus prejudgment
interest and costs of suit. In February 2002, the Company filed
a motion to dismiss the complaint, which the plaintiff has
opposed. The judge has not set a hearing date for the motion.
SONICblue intends to dispute the plaintiffs claims and
vigorously defend itself against this action.

On October 17, 2001, Skyline Capital
Associates, LLC filed a lawsuit in the San Mateo County
Superior Court alleging that SONICblue breached an agreement for
tax consulting services and seeking payment of $3.2 million
for consulting fees and interest. In November 2001, SONICblue
filed a counter claim against Skyline for $750,000. In March
2002, SONICblue, Skyline and Skylines principal entered
into a settlement agreement pursuant to which the parties would
resolve their dispute for $2.4 million. In June 2002, after
SONICblue had paid approximately $2.3 million under the
settlement agreement, a dispute over the settlement arose. As of
the date of this report, Skyline has not responded to
SONICblues attempts to engage Skyline in discussion
regarding a final resolution of this matter.




Item 3.     Quantitative
and Qualitative Disclosures About Market Risk



| |                   
| | ------------------
| | Interest Rate Risk

The Companys exposure to market risk for
changes in interest rates relates primarily to its investment
portfolio, its convertible subordinated notes and its senior
subordinated convertible debentures. The Companys
investment portfolio principally consists of short-term fixed
income securities. The primary objective of the Companys
investment activities is to maintain the safety of principal and
preserve liquidity while maximizing yields without significantly
increasing risk. This is accomplished by investing in marketable
investment grade securities, and by limiting exposure to any one
issue or issuer. The Company does not use derivative financial
instruments in its investment portfolio and due to the nature of
its investments, does not expect its operating results or cash
flows to be significantly affected by potential changes in
interest rates. At June 30, 2002, the market value of these
investments, which were classified as cash equivalents,
approximated cost.

In September 1996, the Company completed a
private placement of $103.5 million aggregate principal
amount of convertible subordinated notes. The notes mature in
2003. Interest is payable semi-annually at 5 3/4% per
annum. The notes are convertible at the option of the note
holders into the Companys common stock at an initial
conversion price of $19.22 per share, subject to adjustment.
During 2000, $0.2 million in notes were converted into
common stock. Beginning in October 1999, the notes became
redeemable at the option of the Company at an initial redemption
price of 102% of the principal amount. The market value of the
convertible subordinated notes at March 31, 2002 and 2001
was approximately $88.0 million and $117.1 million,
respectively.

In April 2002, the Company completed a private
placement of $75.0 million in aggregate principal amount of
its 7 3/4% secured senior subordinated convertible
debentures due 2005 to three institutional investors. The
debentures are convertible into SONICblue common stock at a
conversion price of $19.22 per

39



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share subject to standard anti-dilution
adjustments. Under the terms of the debentures the Company may
pay up to 50% of the interest payments on the debentures in
shares of SONICblue common stock.




| |                  
| | -----------------
| | Equity Price Risk

The Companys largest financial asset is its
UMC shares, which are traded on the Taiwan Stock Exchange. The
market price of UMCs stock is subject to volatility due to
general market conditions, including changes in the
semiconductor industry and the Taiwanese market, as well as
actual or anticipated changes in UMCs business prospects
or quarterly or yearly operating results. Because the UMC shares
are SONICblues largest asset, when the price per share of
UMCs stock increases or declines, the price of
SONICblues common stock on the Nasdaq National Market
tends to follow changes in UMCs stock price. Fluctuations
in the price of SONICblue common stock caused by changes in
UMCs stock price may or may not reflect SONICblues
actual or anticipated business prospects or quarterly results.
Also, fluctuations in UMCs stock price may cause
fluctuations in SONICblues stock price when there is no
material news regarding SONICblue or any change in its results.
Future fluctuations in the value of SONICblues UMC shares
could negatively impact SONICblues financial condition.



| |                                        
| | ---------------------------------------
| | Foreign Currency Exchange Rate
    Risk

The Company invoices its customers in U.S.
dollars for all products. The Company is exposed to foreign
exchange rate fluctuations as the financial results of its
foreign subsidiaries are translated into U.S. dollars in
consolidation. The foreign subsidiaries maintain their accounts
in the local currency of the foreign location in order to
centralize the foreign exchange risk with the parent company. To
date this risk has not been material.




PART II.     OTHER
INFORMATION






Item 1.     Legal
Proceedings


The Internet, digital media, entertainment and
consumer electronics industries are characterized by frequent
litigation, including litigation regarding patent and other
intellectual property rights. SONICblue is party to various
legal proceedings that arise in the ordinary course of business.
While we currently believe that the ultimate outcome of these
proceedings, individually and in the aggregate, will not have a
material adverse effect on the Companys financial position
or overall trends in results of operations, litigation is
subject to inherent uncertainties. There can be no assurance
that an adverse result or settlement with regard to these
lawsuits would not have a material adverse effect on
SONICblues financial condition or results of operations.

Beginning in November 1997, a number of
complaints were filed in federal and state courts seeking
unspecified damages on behalf of an alleged class of persons who
purchased shares of SONICblues common stock at various
times between April 18, 1996, and November 3, 1997.
The complaints named as defendants SONICblue, certain of its
officers and former officers, certain directors of SONICblue,
and Deloitte & Touche, the companys former
auditors, and asserted that they violated federal and state
securities laws by misrepresenting and failing to disclose
certain information about SONICblues business. In
addition, certain stockholders filed derivative actions in the
state courts of California and Delaware seeking recovery on
behalf of SONICblue, alleging, among other things, breach of
fiduciary duties by such individual defendants. The plaintiffs
in the derivative action in Delaware took no steps to pursue
their case. The derivative cases in California State court were
consolidated, and plaintiffs filed a consolidated amended
complaint. The court entered a stipulated order in those
derivative cases suspending court proceedings and coordinating
discovery in them with discovery in the class actions in
California State courts. In late 2001, the derivative plaintiffs
gave notice terminating that stay, and the parties stipulated
that a second amended consolidated complaint might be filed in
April 2002. On plaintiffs motion, the federal court
dismissed the federal class actions without prejudice. The class
actions in California State court were consolidated, and
plaintiffs filed a consolidated amended complaint. SONICblue
answered that complaint and discovery proceeded. In January
2001, four of the insurance carriers which issued directors and
officers insurance to SONICblue filed suit against all parties
named as defendants in the securities litigation, claiming that
the carriers have no obligation to provide coverage under the
California Insurance Code. In May 2001, the court entered an
order staying the insurance

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action pending resolution of the securities
litigation. In February 2002, the California Superior Court for
Santa Clara County entered its preliminary approval of an
agreement to settle the consolidated state court class action
lawsuit. Under the terms of the class action settlement,
SONICblue will contribute 2,401,501 shares of SONICblue
common stock and Deloitte & Touche will contribute up to
$250,000 in full settlement of all claims. In April 2002, the
Superior Court granted final approval to that settlement,
dismissing the case. In May 2002, the Superior Court also
approved the settlement of the related California derivative
litigation. The derivative settlement calls for the defendants
to contribute to the settlement their respective benefits under
certain directors and officers insurance policies in an amount
of approximately $4.6 million which, net of attorneys
fees and litigation costs, would be paid to SONICblue, which
payments have been made. The total net cost of these settlements
to SONICblue, net of insurance, is expected to approximate
$8.6 million. These charges were recorded in
SONICblues fourth quarter ended December 31, 2001. In
addition the Company settled the claim of a purchaser of the
Companys common stock in 1996 and 1997, by payment of
$100,000 and 300,000 shares of the Companys common
stock, the net cost of which was recorded in the quarter ended
March 31, 2002. The judgments in the class action and the
derivative litigation are both final, and the insurance
litigation has been dismissed.


SONICblue has been defending several putative
class action lawsuits naming Diamond, which were filed in June
and July 1996 and June 1997 in the California Superior Court for
Santa Clara County and the U.S. District Court for the Northern
District of California. The plaintiffs alleged that Diamond and
the other defendants made various material misrepresentations
and omissions during the class period. The parties have agreed
to settle this matter for a payment of $15.0 million, and
final court approval of that settlement was obtained, and the
cases dismissed, in April 2002. SONICblue funded
$4.5 million of the settlement in November 2000. SONICblue
previously accrued this amount in connection with the merger
with Diamond. SONICblue believes that Diamonds insurance
covers the remaining $10.5 million of the settlement;
Diamonds insurers have funded that amount into the
settlement, although one of these insurers has commenced
arbitration disputing its obligation to pay $3.0 million of
the $10.5 million. The contesting insurer maintains that
indemnification of its share of the settlement is barred by
virtue of a recent California appellate decision. The
arbitration tribunal issued an order in April 2002, stating that
the California state law claim in the class action was
uninsurable, but that factual questions were presented as to the
allocation of the settlement amount as between the state law
claim and other claims included in the settlement documents.
Further proceedings are contemplated before the tribunal, but no
schedule has as yet been set.

In November 2001, four former holders of ReplayTV
preferred shares filed a petition for appraisal in the Chancery
Court in the State of Delaware asserting their dissenters rights
of appraisal and seeking the fair value of their ReplayTV shares
in cash in lieu of the SONICblue shares to be issued to them as
provided in SONICblues merger agreement with ReplayTV. In
December 2001, ReplayTV filed its response to plaintiffs
petition. In addition, in December 2001, the same four former
holders of ReplayTV preferred shares filed a complaint in the
Chancery Court in the State of Delaware asserting that ReplayTV
and its former directors breached their fiduciary duties in
connection with Replays merger by engaging in
self-dealing, failing to make appropriate disclosures to
shareholders and failing to maximize the value for them in the
merger, resulting in an allocation of an insufficient amount of
the merger consideration to the ReplayTV preferred stockholders.
The complaint seeks at least $7,249,990.50 in
damages. In its merger agreement with ReplayTV, SONICblue agreed
to indemnify ReplayTVs former directors against this type
of lawsuit, among other things. In February 2002, ReplayTV and
the former ReplayTV directors filed their answer. SONICblue and
ReplayTV intend to dispute the plaintiffs claims and
vigorously defend these actions. The cases are currently in the
pretrial discovery stage.

In October and November, 2001, a group of 28
entertainment companies including, among others, Paramount
Pictures Corporation, Disney Enterprises, Inc. and the three
major television networks filed four lawsuits against SONICblue
and its ReplayTV, Inc. subsidiary in the U.S. District Court in
Los Angeles, California. The lawsuits allege that the
Companys planned manufacture and sale of the ReplayTV
4000, which allows users to skip commercials and to use the
Internet to send recorded material to other ReplayTV 4000 users,
constitutes copyright infringement, among other claims. The
plaintiffs in the lawsuits are seeking an injunction prohibiting
the Company from including these features in its video products.
Although one of

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the lawsuits originally alleged that the
Companys Go-Video VCRs featuring the commercial skipping
technology similarly violate the copyright laws, in their
amended complaint plaintiffs eliminated these claims in November
2001. The parties have commenced discovery. The District Court
preliminarily scheduled a consolidated trial in August 2002 but
removed the trial from its calendar in April 2002 and has not
set a new trial date. SONICblue intends to dispute the
plaintiffs claims and defend this action vigorously.


In June, 2002, a group of five individual
ReplayTV 4000 owners filed a lawsuit in the United States
District Court in Los Angeles against the 28 entertainment
companies described above, seeking a declaration that their use
of the ReplayTV 4000 device is fair use and does not infringe
copyrights. Those individuals named SONICblue and its ReplayTV,
Inc. subsidiary as nominal defendants, although those
individuals interests are substantially aligned with the
Companys position. This complaint does not demand any
affirmative relief against the Company, but purports to reserve
the right to amend to seek an injunction to prohibit the Company
from discontinuing support for features that were advertised or
served as inducements for consumers purchases, absent
restitution to such consumers.

On December 12, 2001, SONICblue filed a
complaint for patent infringement against TiVo, Inc. in the
United States District Court for the Northern District of
California. SONICblues complaint generally alleges that
TiVo is infringing one of its patents by licensing and offering
to license its DVR technology and offering its program guide
service. In response, TiVo filed an answer and counterclaim
against SONICblue that denies infringement of SONICblues
patent and that alleges that the patent is invalid. On
January 23, 2002, TiVo filed a separate action in the same
court, but assigned to a different judge, that generally alleges
that SONICblue is infringing one of TiVos patents by
making, selling, offering to sell its ReplayTV DVRs. The parties
have agreed to suspend further proceedings in the two cases
through Fall 2002 to facilitate settlement discussions between
them. If the cases do not settle, SONICblue intends to
vigorously defend itself against the allegations made in
TiVos complaint and counterclaim.

On November 28, 2001, Techsearch, LLC filed
a complaint for patent infringement against a number of consumer
electronics companies, including SONICblue, in the United States
District Court for the Northern District of Illinois.
Techsearchs complaint generally alleges that SONICblue is
infringing one of its patents by making, selling, and offering
to sell its Rio Volt CD players that are capable of playing CDs
encoded with audio tracks in the MP3 format. SONICblue intends
to dispute the plaintiffs claims and vigorously defend
itself against the allegations made in Techsearchs
complaint. This action was stayed by order of the Court on or
about May 1, 2002, pending a reexamination of the patent
asserted by Techsearch by the U.S. Patent and Trademark Office.

On February 14, 2000, Robert C. Price filed
a purported class action lawsuit in the Circuit Court of Monroe
County, State of Indiana against the Company and Diamond
alleging violations of the California Business and Professions
Code section 17200 and the California Song-Beverly Act,
which covers consumer warranties. The lawsuit alleges that
certain of the Companys Rio 300 MP3 player retail
boxes, which were discontinued in approximately 1999, are
misleading because the boxes indicate that computer software
included in the package allows the purchaser to convert audio
tracks on CDs to the MP3 audio format, but the software included
with the product permitted only 50 conversions. The Company
answered the complaint on April 27, 2000, denying
plaintiffs allegations. Status conferences were conducted
on July 26, 2000, January 10, 2001, and April 17,
2002. Discovery has commenced. No class has been certified, but
the briefing on the plaintiffs motion for class
certification is expected to be completed by Fall 2002, with a
hearing on class certification issues to be scheduled
thereafter. SONICblue intends to contest the certification of
the purported class, dispute the lawsuits allegations and
defend this action vigorously.

In November 2001, Pac Tec, a division of La
France Corporation, filed a civil action against the Company and
one of its suppliers, Manufacturers Services Limited, in
the United States District Court for the Eastern District of
Pennsylvania, alleging claims against both defendants jointly
for breach of contract and promissory estoppel. The plaintiff
seeks damages in excess of $2.5 million, plus prejudgment
interest and costs of suit. In February 2002, the Company filed
a motion to dismiss the complaint, which the plaintiff has
opposed. The judge has not set a hearing date for the motion.
SONICblue intends to dispute the plaintiffs claims and
vigorously defend itself against this action.

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On October 17, 2001, Skyline Capital
Associates, LLC filed a lawsuit in the San Mateo County
Superior Court alleging that SONICblue breached an agreement for
tax consulting services and seeking payment of $3.2 million
for consulting fees and interest. In November 2001, SONICblue
filed a counter claim against Skyline for $750,000. In March
2002, SONICblue, Skyline and Skylines principal entered
into a settlement agreement pursuant to which the parties would
resolve their dispute for $2.4 million. In June 2002, after
SONICblue had paid approximately $2.3 million under the
settlement agreement, a dispute over the settlement arose. As of
the date of this report, Skyline has not responded to
SONICblues attempts to engage Skyline in discussion
regarding a final resolution of this matter.




Item 2.     Changes
in Securities and Use of Proceeds

In April 2002, the Company completed a private
placement of $75.0 million in aggregate principal amount of
its 7 3/4% secured senior subordinated convertible
debentures due 2005 to three institutional investors. The
Company also issued warrants to purchase up to
7,500,000 shares of its common stock in the transaction to
the investors, and a warrant to purchase 293,805 shares of
its common stock to the placement agent for the transaction. The
private placement resulted in gross proceeds to the Company,
prior to the exercise of the warrants, of approximately
$62.3 million. The sale of the debentures and the warrants
closed on April 22, 2002. The debentures are convertible
into SONICblue common stock at a conversion price of $19.22 per
share subject to standard anti-dilution adjustments. The
warrants are fully vested and exercisable at any time until
April 22, 2007 at an exercise price of $3.39 per share
subject to standard anti-dilution adjustments. The
Companys repayment obligation on the debentures is secured
by a pledge of 21,426,586 shares of UMC stock. The
institutional investors also have an option to purchase these
UMC shares from the Company. Under the terms of the debentures
the Company may pay up to 50% of the interest payments on the
debentures in shares of its common stock. The Company relied on
the exemption provided by Section 4(2) of the Securities
Act of 1933 (the Act) and Regulation D under
the Act, because the transaction did not involve a public
offering and each of the three institutional investors
represented that it was an accredited investor as
such term is defined by the rules of the Securities and Exchange
Commission promulgated under the Act.

In April and May 2002, in connection with the
settlement of class action lawsuits filed at various times in
1997, the Company issued an aggregate of 1,897,643 shares of its
common stock to one plaintiff and to plaintiffs counsel.
For the issuance of 300,000 shares, the Company relied on the
exemption provided by Section 4(2) of the Act. The issuance of
the remaining 1,597,643 shares were exempt from registration
pursuant to Section 3(a)(10) of the Act.




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

(a) The Annual Meeting of Stockholders was
held on May 22, 2002.

(b) The matters voted upon at the meeting
and results of the voting with respect to those matters were as
follows:



| |                           
| | --------------------------
| | (1) Election of Directors.

|                     |  |           |            |          |  |  |            | 
|-------------------- |  | --------- | ---------- | -------- |  |  | ---------- | 
|                     |  | Votes For |            | Withheld
|                     |  |           |            |         
|Kenneth F. Potashner |  |           | 61,690,898 |          |  |  | 10,258,102 | 
|Edward M. Esber, Jr. |  |           | 61,765,302 |          |  |  | 10,183,698 | 
|Terry N. Holdt       |  |           | 61,780,682 |          |  |  | 10,168,318 | 
|Robert P. Lee        |  |           | 61,777,852 |          |  |  | 10,171,148 | 
|James T. Schraith    |  |           | 61,777,145 |          |  |  | 10,171,855 | 



| |                                                                                 
| | --------------------------------------------------------------------------------
| | (2) Confirmation of Ernst & Young LLP as
    the Companys independent auditors.

|          |            |         |  |         |         |  |  |  |         | 
|--------- | ---------- | ------- |  | ------- | ------- |  |  |  | ------- | 
|Votes For |            | Against |  | Abstain
|          |            |         |  |        
|          | 71,098,305 |         |  |         | 740,784 |  |  |  | 109,911 | 

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Item 6.     Exhibits
and Reports on Form 8-K

(a) Exhibits:

None.

(b) Reports on Form 8-K:

On April 23, 2002, SONICblue filed a current
report on Form 8-K reporting under Item 5 the issuance
and sale of $75 million aggregate principal amount of its
7 3/4% secured senior subordinated convertible debentures
due 2005 and warrants to purchase up to 7.5 million shares
of its common stock.

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SIGNATURES

Pursuant to the requirements 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.



| |                                                                             
| | ----------------------------------------------------------------------------
| | SONICBLUE INCORPORATED                                                      
| | (Registrant)                                                                
|
| | /s/ MARCUS SMITH                                                            
| |                                                                             
| | Marcus Smith                                                                
| | Vice President and Interim Chief Financial
    Officer                      
| | (Duly Authorized Officer and Principal Financial
    and Accounting Officer)

Date: August 14, 2002

This certification by the Companys interim
chief executive officer and interim chief financial officer of
this report on Form 10-Q, as required by Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350) have been
submitted to the Securities and Exchange Commission as
additional correspondence accompanying this report.

45