<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

        [X]     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934

                     For the quarter ended June 30, 2001 or

        [ ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934

             For the transition period from __________ to __________

                         Commission file number 0-21126

                             SONICBLUE INCORPORATED
             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                                             <C>
                       DELAWARE                                              77-0204341
   (State or other jurisdiction of incorporation or             (I.R.S. Employer Identification No.)
                     organization)

            2841 Mission College Boulevard
                Santa Clara, California                                         95054
       (Address of principal executive offices)                              (Zip Code)
</TABLE>


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

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                                 Yes [X] No [ ]

The number of shares of the Registrant's Common Stock, $.0001 par value,
outstanding at July 31, 2001 was 82,882,230.


<PAGE>   2
                             SONICBLUE INCORPORATED
                                    FORM 10-Q

                                      INDEX


<TABLE>
<CAPTION>
                                                                                                   PAGE
                                                                                               --------------
<S>        <C>                                                                                 <C>
PART I.    CONDENSED CONSOLIDATED FINANCIAL INFORMATION

Item 1.    Condensed Consolidated Financial Statements:

           Condensed Consolidated Balance Sheets at June 30, 2001 and December 31, 2000              3

           Condensed Consolidated Statements of Operations for the three months and six
           months ended June 30, 2001 and 2000                                                       4

           Condensed Consolidated Statements of Cash Flows for the six months ended
           June 30, 2001 and 2000                                                                    5

           Notes to Unaudited Condensed Consolidated Financial Statements                            6

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of
           Operations                                                                               12

Item 3.    Quantitative and Qualitative Disclosures About Market Risk                               32

PART II.   OTHER INFORMATION

Item 1.    Legal Proceedings                                                                        33

Item 2.    Changes in Securities                                                               Not Applicable

Item 3.    Defaults Upon Senior Securities                                                     Not Applicable

Item 4.    Submission of Matters to a Vote of Security Holders                                      34

Item 5.    Other Information                                                                   Not Applicable

Item 6.    Exhibits and Reports on Form 8-K                                                         35

Signatures                                                                                          35
</TABLE>


                                       2


<PAGE>   3
PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

                             SONICBLUE INCORPORATED
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                (In thousands, except shares and per share data)
                                  (Unaudited)


<TABLE>
<CAPTION>
                                                  JUNE 30,        DECEMBER 31,
                                                    2001             2000(1)
                                                -----------       -----------
<S>                                             <C>               <C>
                        ASSETS
Current assets:
   Cash and equivalents                         $     8,394       $    36,582
   Investment -- UMC                                151,082           228,673
   Other short-term investments                       6,383             9,017
   Accounts receivable (net of allowances
    of $7,861 in 2001 and $7,790 in 2000)            52,990            85,950
   Inventories, net                                  29,328            86,727
   Prepaid expenses and other                         6,939             9,734
                                                -----------       -----------
               Total current assets                 255,116           456,683

Property and equipment, net                          13,852            24,761
Investment -- UMC                                   133,711           406,363
Deferred income taxes                                41,088                --
Goodwill and intangible assets                       52,342           162,381
Other assets                                         52,807            49,117
                                                -----------       -----------
               Total                            $   548,916       $ 1,099,305
                                                ===========       ===========

      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Accounts payable                             $    80,921       $    99,296
   Notes payable                                     65,587            72,672
   Accrued liabilities                              100,906            45,354
   Deferred income taxes                             41,088            69,563
   Deferred revenue                                   6,864             8,287
                                                -----------       -----------
               Total current liabilities            295,366           295,172

Long-term deferred taxes                                 --            25,140
Other liabilities                                     3,708             4,040
Convertible subordinated notes                      103,300           103,300
                                                -----------       -----------
               Total liabilities                    402,374           427,652

Stockholders' equity:
   Common stock, $.0001 par value;
    175,000,000 shares authorized:
    82,875,778 and 93,054,332 shares
    outstanding in 2001 and 2000,
    respectively                                    534,586           602,566
   Accumulated other comprehensive loss              (8,419)         (199,599)
   Retained earnings (accumulated deficit)         (379,625)          268,686
                                                -----------       -----------
               Total stockholders' equity           146,542           671,653
                                                -----------       -----------
               Total                            $   548,916       $ 1,099,305
                                                ===========       ===========
</TABLE>

(1)   Derived from audited financial statements


         See accompanying notes to the unaudited condensed consolidated
                              financial statements.


                                       3


<PAGE>   4
                             SONICBLUE INCORPORATED
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                     THREE MONTHS ENDED              SIX MONTHS ENDED
                                                          JUNE 30,                        JUNE 30,
                                                 -------------------------       -------------------------
                                                    2001            2000           2001            2000
                                                 ---------       ---------       ---------       ---------
<S>                                              <C>             <C>             <C>             <C>
Net sales                                        $  29,508       $ 135,820       $  79,394       $ 297,539

Cost of sales                                       97,019         130,816         163,674         279,131
                                                 ---------       ---------       ---------       ---------
Gross margin                                       (67,511)          5,004         (84,280)         18,408

Operating expenses:
    Research and development                         6,446          21,274          17,121          42,031
    Selling, marketing and administrative           34,099          27,462          58,985          57,074
    In-process research and development                878              --             878              --
    Restructuring expense and impairment charge    122,233              --         122,233              --
    Amortization of goodwill and intangibles        11,164          11,083          22,288          21,559
                                                 ---------       ---------       ---------       ---------
               Total operating expenses            174,820          59,819         221,505         120,664
                                                 ---------       ---------       ---------       ---------
Loss from operations                              (242,331)        (54,815)       (305,785)       (102,256)

Gain on sale of  manufacturing joint venture            --           7,266              --          14,738
Gain (loss) on UMC investment                      (69,919)             --        (527,957)        880,166
Gain (loss) on other investments                   (20,858)          2,678         (21,476)          5,917
Equity (loss) of investees                              --          (6,024)           (114)         (6,381)
Other income (expense), net                         (4,099)            849          (7,212)            672
                                                 ---------       ---------       ---------       ---------
Income (loss) before income taxes                 (337,207)        (50,046)       (862,544)        792,856
Income tax expense (benefit)                       (24,666)        (13,788)       (214,233)        336,871
                                                 ---------       ---------       ---------       ---------
Net income (loss)                                $(312,541)      $ (36,258)      $(648,311)      $ 455,985
                                                 =========       =========       =========       =========
Earnings per share amounts:
    Basic                                        $   (3.83)      $   (0.40)      $   (7.42)      $    5.19
    Diluted                                      $   (3.83)      $   (0.40)      $   (7.42)      $    4.55

Shares used in computing per share amounts:
    Basic                                           81,503          91,402          87,402          87,837
    Diluted                                         81,503          91,402          87,402         100,574
</TABLE>


         See accompanying notes to the unaudited condensed consolidated
                              financial statements.


                                       4


<PAGE>   5
                             SONICBLUE INCORPORATED
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                                    SIX MONTHS ENDED
                                                                         JUNE 30,
                                                                -------------------------
                                                                   2001           2000
                                                                ---------       ---------
<S>                                                             <C>             <C>
Operating activities:
  Net income (loss)                                             $(648,311)      $ 455,985
  Adjustments to reconcile net income (loss) to net
    cash used for operating activities:
    Deferred income taxes                                        (214,480)        303,496
    Depreciation                                                    2,917          10,905
    Amortization                                                   22,289          21,740
    Gain on sale of shares of manufacturing joint venture              --         (14,738)
    (Gain)/loss on UMC investment                                 520,368        (880,166)
    (Gain)/loss on other investments                               20,858          (5,917)
    Impairment of long term assets                                109,067              --
    Write-off acquired in-process research and development            878              --
    Other                                                             114              --
  Changes in assets and liabilities:
            Accounts receivable                                    22,063           3,094
            Inventories                                            19,167         (41,236)
            Prepaid expenses and other assets                      (2,295)           (526)
            Accounts payable                                      (10,124)        (34,611)
            Accrued liabilities and other liabilities              53,449          (9,883)
            Income taxes payable                                      (72)             --
            Deferred revenue                                       (1,022)            818
                                                                ---------       ---------
  Net cash used for operating activities                         (105,134)       (184,658)
                                                                ---------       ---------
Investing activities:
  Property and equipment purchases, net                              (294)         (7,384)
  Notes receivable                                                (30,100)             --
  Sale (purchase) of short-term investments                       125,547          64,472
  Acquisition of Sensory Science Corporation,
     net of cash acquired                                           2,500              --
  Sale of manufacturing joint venture                                  --          14,738
  Gain on other investments                                            --           5,917
  Investment in technologies                                           --         (36,098)
  Other                                                            (4,234)            802
                                                                ---------       ---------
  Net cash from (used for) investing activities                    93,419         (42,447)
                                                                ---------       ---------
Financing activities:
  Sale of common stock                                              3,411         157,869
  Repayments of notes payable                                     (19,866)        (37,187)
                                                                ---------       ---------
  Net cash (used for) provided by financing activities            (16,455)        120,682
                                                                ---------       ---------
Effect of exchange rate changes                                       (18)             (8)
                                                                ---------       ---------
Net decrease in cash and equivalents                              (28,188)        (21,537)
Cash and equivalents at beginning of period                        36,582          45,825
                                                                ---------       ---------
Cash and equivalents at end of period                           $   8,394       $  24,288
                                                                =========       =========
</TABLE>


         See accompanying notes to the unaudited condensed consolidated
                              financial statements.


                                       5


<PAGE>   6
                             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 with the exception of the in-process research and development charge
discussed in Note 2, necessary for a fair presentation of the financial position
at June 30, 2001 and December 31, 2000, and the operating results and cash flows
for the six months ended June 30, 2001 and 2000. 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, 2000, included in
the Company's Form 10-K/A filed with the Securities and Exchange Commission.

        The results of operations for the six months ended June 30, 2001 are not
necessarily indicative of the results that may be expected for the future
quarters or the year ending December 31, 2001. Certain reclassifications of 2000
amounts were made in order to conform to the 2001 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 assumptions set forth
in Note 2 and the Management's Discussion and Analysis section of this Quarterly
Report on Form 10-Q regarding revenue growth, gross margin trends, cost trends
and cost of capital which underlie the Company's calculation of the in-process
research and development expenses 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/A for the year
ended December 31, 2000 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 these forward-looking statements 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 Assets of Number Nine

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

Purchase of Empeg Limited

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

Transfer of assets to S3 Graphics Co., Ltd.

        On January 3, 2001, SONICblue completed the transactions contemplated by
the Amended and Restated Investment Agreement, dated as of August 28, 2000
between SONICblue, VIA Technologies, Inc. ("VIA") and a joint venture. At the
closing, SONICblue completed the transfer of its graphics chips assets and
liabilities to a joint venture ("JV") owned by a wholly owned subsidiary of
SONICblue and VIA. Under the terms of the agreement, SONICblue received 13
million shares of its stock as initial payment from VIA and 100


                                       6


<PAGE>   7
million shares of Class A Common Stock of the JV. SONICblue held the 13 million
shares as treasury shares until their cancellation in April 2001. The agreement
provides that, upon occurrence of certain events, SONICblue shall pay damages
subject to a maximum damages cap. Also, SONICblue may receive earn-out payments
if the new venture meets certain profitability goals. The effect of the earn-out
payments, if any, has not been included in the unaudited financial statements.

        The agreement provides that the Class A shareholder, Class B shareholder
(VIA) and Class C shareholder (an independent third party) shall have 50%, 48%
and 2%, respectively, of the voting power of JV, irrespective of the actual
number of outstanding shares of such class with respect to the election of
directors, and own 0.1%, 99.4% and 0.5%, respectively, of the economic interest
of JV.

        At closing, SONICblue granted a wholly owned subsidiary of VIA a warrant
(the "Warrant") to purchase up to 2 million shares of SONICblue common stock at
an exercise price of $10.00 per share, for an aggregate exercise price of $20
million. The Warrant expires on January 3, 2005, unless terminated earlier
pursuant to its terms. The fair value of the Warrant is recorded in the balance
sheet.

Sale of professional graphics division to ATI Technologies

        In March 2001, SONICblue completed the sale to ATI Technologies, Inc. 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 received $2.7 million in cash and is eligible to receive
further financial consideration of up to $7.3 million, contingent upon the Fire
GL graphics business, as operated by ATI, achieving future performance targets.

Purchase of Sensory Science

        On June 27, 2001, SONICblue completed the acquisition of Sensory Science
Corporation, a developer of consumer electronics products, including dual deck
video cassette player/recorders and DVD players. The acquisition was accounted
for as a purchase. At closing each share of Sensory Science common stock was
converted into the right to receive 0.0913 of a share of SONICblue common stock.
As a result of the merger, 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 on June 27, 2001. In connection with
the acquisition of Sensory Science, SONICblue had made loans to Sensory Science
in the amount of $9.8 million as of June 27, 2001, which became part of the
purchase price.

        The purchase price of $20.5 million includes $7.2 million of stock
issued at fair value (fair value being determined as the average price of the
SONICblue at the date the exchange ratio was fixed per the merger agreement),
$0.3 million stock option costs (determined under both the Black-Scholes formula
and in accordance with the merger agreement), cash paid to Sensory Science of
$9.8 million and $3.2 million in estimated expenses of the transaction. The
purchase price was allocated as follows: $(1.6) million to the estimated fair
value of Sensory Science net tangible assets purchased (as of June 27, 2001),
$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, $5.1 million to distribution channel relationships and $13.0
million to goodwill. Goodwill is recorded as a result of consideration paid in
excess of the fair value of net tangible and intangible assets acquired.
Goodwill and identified acquisition related intangible assets are amortized on a
straight-line basis, generally over a five year period. The allocation of the
purchase price to intangibles was based upon management's estimates. The
purchase price and the related allocation is subject to further refinement and
change over the next year.

Purchase of Replay TV, Inc.

        In March 2001, SONICblue signed a definitive agreement to acquire
ReplayTV, Inc., a developer of personal television technology. As described in
Note 9, the acquisition was completed subsequent to June 30, 2001. The
acquisition was accounted for as a purchase. Under the terms of the agreement,
ReplayTV has become a wholly owned subsidiary of SONICblue and SONICblue will
issue an aggregate of 15.5 million shares of common stock and options and
warrants to purchase shares of SONICblue common stock in exchange for all of
ReplayTV's outstanding preferred and common stock. In connection with the
acquisition of ReplayTV, SONICblue had made loans to ReplayTV in the amount of
$18.4 million as of June 30, 2001. These loans became part of the purchase
price at closing in August. The Company has not yet completed its analysis of
the allocation of the purchase price.


                                       7


<PAGE>   8
3.      Inventories

        Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. Inventories consisted of:


<TABLE>
<CAPTION>
                       JUNE 30,       DECEMBER 31,
                        2001            2000
                     -----------      -----------
                           (IN THOUSANDS)
<S>                  <C>              <C>
Raw materials        $     1,716      $    41,734
Work in process            1,091           14,222
Finished goods            26,521           30,771
                     -----------      -----------
   Total             $    29,328      $    86,727
                     ===========      ===========
</TABLE>


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 a 20% stock dividend, or approximately 50.4 million shares of UMC
stock, in April 2000, increasing SONICblue's holdings to approximately 302
million shares of UMC stock. The Company sold 15 million shares of UMC stock in
2000 and 73 million shares in the first six months of 2001 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 classified as restricted because
they are subject to restrictions on their sale that lapse over a three-year
period from the date of the merger. At June 30, 2001, approximately 101 million
shares were subject to restrictions that will lapse in one year or more and are
recorded as a long-term investment at market values as of June 30, 2001. The
unrestricted shares and shares where the restrictions will lapse in one year or
less are recorded as a current asset and are valued at market in accordance with
SFAS 115. The available-for-sale portion of the Company's investment was
marked-to-market through other comprehensive income as required by SFAS 115. The
restricted shares were originally recorded at cost. At December 31, 2000, the
market value of both the short-term and long-term 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 and second quarters 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. There
is a great deal of uncertainty regarding when the semiconductor industry will
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 $468.0 million for the six months ended June 30, 2001 based on the
market value at that date. Also, the Company's sale of 73 million shares of UMC
in the first six months of 2001 resulted in a realized loss of $60 million. As
of June 30, 2001, SONICblue's 214 million UMC shares were worth approximately
$285 million, based on the closing price of UMC shares on the Taiwan Stock
Exchange on that date and the U.S. dollar to New Taiwan Dollar exchange rate
prevailing on that date. The 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, 2001
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 is value will be recorded as expense in the statement of operations.

Investment in Rioport

        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. As of June 30,
2001, the Company held approximately 33% of RioPort's outstanding stock. The
Company recorded its equity in the loss of RioPort of $0.1 million and
$6.4 million for the six months ended June 30, 2001 and 2000, respectively.


                                       8


<PAGE>   9
Investment in S3-VIA, Inc.

        In November 1999, the Company established a joint venture ("JVI") with
VIA to bring high-performance integrated graphics and core logic chip sets to
the volume OEM desktop and notebook PC markets. The venture, S3-VIA, Inc. has
joint funding, exclusive access to both companies' technology and distribution
rights for developed products between SONICblue and VIA. The Company owns 50.1%
of the voting common stock of the joint venture. Accordingly, the Company
consolidates the accounts of S3-VIA, Inc. in its consolidated financial
statements.

        For the three and six months ended June 30, 2001, JVI had sales of $3.8
million and $21.6 million, and net income (loss) of $(0.5) million and $0.8
million, respectively. Total assets of JVI at June 30, 2001 and December 31,
2000 were $32.3 million and $17.9 million, respectively.

5.      Notes Payable

        At June 30, 2001, the Company had an $80.0 million domestic bank
facility permitting borrowings at the rate of LIBOR plus 2%. This bank facility
expires in November 2001. The covenants covering this debt agreement pertain to
minimum levels of collateral coverage and tangible net worth, quarterly
profitability and minimum levels of liquidity. As of June 30, 2001, the Company
was in compliance with all loan covenants. The Company has pledged 80.1 million
UMC shares to secure the loan facility. Sensory Science Corporation has a line
of credit from a major supplier and loans under a line of credit with Congress
Financial Corporation. The financing agreement with Congress Financial was first
entered into in October 1992 and was last amended during June 2000. The maximum
line of credit is $20.0 million, limited by a borrowing base determined by
specific inventory and receivable balances. Interest is charged at prime plus
0.5%. Borrowings, included in Notes Payable, were $65.6 and $72.7 million under
these facilities at June 30, 2001 and December 31, 2000, respectively.

        As of June 30, 2001 and December 31, 2000, the Company's future
payments on debt related to notes payable, lines of credit and capital lease
obligations are due in 2001, therefore all amounts have been classified as
current.

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

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


<TABLE>
<CAPTION>
                                                                  THREE MONTHS                   SIX MONTHS
                                                                 ENDED JUNE 30,                 ENDED JUNE 30,
                                                           -------------------------       -------------------------
                                                              2001           2000             2001           2000
                                                           ---------       ---------       ---------       ---------
                                                                   (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                        <C>             <C>             <C>             <C>
NUMERATOR
   Net income (loss)
      Basic                                                $(312,541)      $ (36,258)      $(648,311)      $ 455,985
      Interest expense on subordinated debt                        -               -               -           1,932
                                                           ---------       ---------       ---------       ---------
      Diluted                                              $(312,541)      $ (36,258)      $(648,311)      $ 457,917
                                                           =========       =========       =========       =========

DENOMINATOR
    Denominator for basic earnings (loss) per share           81,503          91,402          87,402          87,837
    Common stock equivalents                                       -               -               -           6,496
    Subordinated debt                                              -               -               -           6,241
                                                           ---------       ---------       ---------       ---------
    Denominator for diluted earnings (loss) per share         81,503          91,402          87,402         100,574
                                                           =========       =========       =========       =========
Basic earnings (loss) per share                            $   (3.83)      $   (0.40)      $   (7.42)      $    5.19
Diluted earnings (loss) per share                          $   (3.83)      $   (0.40)      $   (7.42)      $    4.55
</TABLE>


                                       9


<PAGE>   10
7.      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
loss, net of tax:


<TABLE>
<CAPTION>
                                               JUNE 30,         DECEMBER 31,
                                                 2001               2000
                                              -----------       -----------
                                                     (IN THOUSANDS)
<S>                                           <C>               <C>
Unrealized gain (loss) on investments         $        --       $  (191,197)
Foreign currency translation adjustments           (8,419)           (8,402)
                                              -----------       -----------
Accumulated other comprehensive loss          $    (8,419)      $  (199,599)
                                              ===========       ===========
</TABLE>


        The following schedule of other comprehensive loss shows the gross
current-period gain (loss) and the reclassification adjustment:


<TABLE>
<CAPTION>
                                                                 THREE MONTHS ENDED               SIX MONTHS ENDED
                                                                       JUNE 30,                       JUNE 30,
                                                              ------------------------       -------------------------
                                                                2001           2000             2001           2000
                                                              ---------      ---------       ---------       ---------
                                                                                   (IN THOUSANDS)
<S>                                                           <C>            <C>             <C>             <C>
Unrealized gain on investments:
  Unrealized gain (loss)on available-for-sale securities      $   1,208      $ (47,496)      $     898       $ (46,458)
  Less: reclassification adjustment for (gain)
     loss realized in net income                                     --             (2)        190,299          (1,996)
                                                              ---------      ---------       ---------       ---------
Net unrealized loss on investments                                1,208        (47,498)        191,197         (48,454)
Foreign currency translation adjustments                             --              1             (17)             (8)
                                                              ---------      ---------       ---------       ---------
Other comprehensive income (loss)                             $   1,208      $ (47,497)      $ 191,180       $ (48,462)
                                                              =========      =========       =========       =========
</TABLE>


8.      Contingencies

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

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

        SONICblue has also been defending several putative class action lawsuits
naming Diamond, which were filed in June and July 1996 and June 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of


                                       10


<PAGE>   11
California. Certain former executive officers and directors of Diamond are also
named as defendants. The plaintiffs purport to represent a class of all persons
who purchased Diamond's common stock between October 18, 1995 and June 20, 1996,
or the Class Period. The complaints allege claims under the federal securities
laws and California law. The plaintiffs allege that Diamond and the other
defendants made various material misrepresentations and omissions during the
Class Period. The complaints do not specify the amount of damages sought. On
March 24, 2000, the District Court for the Northern District of California
dismissed the federal action without prejudice. The parties have tentatively
agreed to settle this matter, subject to final documentation and court approval,
for a payment of $15.0 million. SONICblue funded $4.5 million of the settlement
on November 1, 2000. SONICblue previously accrued this amount in connection with
the merger with Diamond. SONICblue believes that Diamond's insurance covers the
remaining $10.5 million of the settlement; Diamond's insurers have funded that
amount into the settlement, although one of these insurers has served a notice
of arbitration disputing its obligation to pay $3 million of the $10.5 million.

        Sega Corporation initiated a claim for arbitration in Tokyo, Japan
against Diamond in December 1998. The claim, which arose out of an agreement
entered into between Sega and Diamond in September 1995, in which Sega agreed to
provide Diamond with Sega game software that Diamond would bundle with its 3-D
graphics board, "The Edge," was settled in March 2001 for an amount that
approximated the amount the Company had previously provided for.

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

        On January 6, 2000, PhoneTel Communications, Inc. filed a complaint for
patent infringement against a group of defendants, including Diamond, in the
United States District Court for the Northern District of Texas. The settlement
of this lawsuit was effective in April 2001.

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

9.      Subsequent Events

On August 1, 2001 SONICblue acquired ReplayTV, Inc., a developer of personal
television technology. Under the terms of the agreement, ReplayTV has become a
wholly owned subsidiary of SONICblue, and SONICblue will issue an aggregate of
15.5 million shares of common stock and options and warrants to purchase shares
of SONICblue common stock in exchange for all of ReplayTV's outstanding equity,
and ReplayTV will become a wholly owned subsidiary of SONICblue. In connection
with the acquisition of ReplayTV, SONICblue had made loans to ReplayTV in the
amount of $18.4 million at June 30, 2001.

10.     New Accounting Pronouncement

        In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 141, "Business Combination" ("FAS 141") and
Financial Accounting Standards Board issued Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). FAS 141
eliminates the pooling-of-interests method of accounting for business
combinations except for qualifying business combinations that were initiated
prior to June 1, 2001. FAS 141 further clarifies the criteria to recognize
intangible assets separately from goodwill. The requirements of FAS 141 are
effective for any business combination accounted for by the purchase method that
is completed after June 30, 2001 (i.e., the acquisition date is July 1, 2001 or
thereafter). Under FAS 142, goodwill and indefinite-lived intangible assets are
no longer amortized but are reviewed annually (or more frequently if impairment
indicators arise) for impairment. Separable intangible assets that are not
deemed to have an indefinite life will continue to be amortized over their
useful lives. We will adopt both statements on January 1, 2002 and are currently
evaluating the impact of these statements. We have not yet quantified the impact
of these statements on our operations. During 2002,


                                       11


<PAGE>   12
we will perform the first of the required impairment tests of goodwill as of
January 1, 2002, and we have not yet determined what the effect of these tests
will be on our earnings and financial position. Any impairment resulting from
our initial application of the statements will be recorded as a cumulative
effect accounting change as of January 1, 2002.

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 included reducing the
Company's workforce worldwide by approximately 100 employees in April 2001,
consolidating facilities, discontinuing unprofitable products and closing
offices in unprofitable locations. Restructuring expenses of $122 million in
2001 related to the restructuring plan included the write-off of goodwill and
other intangibles ($110 million), facilities closure expenses ($6 million) and
personnel severance compensation and related expenses ($6 million). As part of
the restructuring, the Company also wrote off $60 million of inventory, through
cost of sales.

        As of June 30, 2001, the remaining portion of the restructuring charge
included in accrued liabilities related to severance and benefits and other
restructuring related costs will be paid during the second half of fiscal 2001.
Amounts related to redundant facilities will be paid over the respective
remaining lease terms.

        Due to the circumstances created by the significant downturns in the
digital media markets, the Company recorded an impairment charge against the
goodwill associated with its acquisitions of Diamond Multimedia, RioPort, and
empeg. These downturns have negatively impacted the forecasted revenues and cash
flows from the Diamond and empeg businesses acquired in 1999 and 2000. 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. This resulted in a $110 million write-down of goodwill and
other intangibles for the quarter ended June 30, 2001. The remaining goodwill
and other intangibles balance of $52 million will continue to be amortized
through 2001 using an estimated useful life of approximately 4 years.


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 intention to continue to supply and support its OEM customers, channel
partners and end-users for existing Diamond-Multimedia branded PC graphics
add-in cards, the timing of availability and functionality of products under
development, product mix, the percentage of net sales represented by any
particular new or current product, trends in average selling prices, the
percentage of export sales and sales to strategic customers, trends in gross
margins, the availability and cost of products from the Company's suppliers, the
Company's intention to focus on core technology and products, expectations
regarding expenses, including research and development expenses and expectations
regarding working capital, capital expenditures, capital requirements and
adequacy of capital resources, are subject to risks and uncertainties that could
cause actual results to differ materially from those projected. These risks and
uncertainties include, but are not limited to, those risks discussed below, as
well as risks relating to SONICblue's ability to develop and timely introduce
products that address market demands, manufacturing difficulties, SONICblue's
ability to work with strategic partners and OEMs, the ability of the Company to
obtain and retain customers, the impact of alternative technological advances
and competitive products, the value of the Company's shares of UMC common stock
and declines in the semiconductor industry, market fluctuations, developments in
and expenses relating to litigation, SONICblue's ability to complete business
transactions and integrate acquired businesses and in a timely manner, the costs
of integrating acquired businesses and technologies, and the matters discussed
in "Factors that May Affect Results." These forward-looking statements speak
only as of the date hereof. The Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any forward-looking
statements contained herein to reflect any change in the Company's expectations
with regard thereto or any change in events, conditions or circumstances on
which any statement is based.

OVERVIEW

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

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

        In October 1999, SONICblue announced that it caused RioPort, Inc.
("RioPort"), formerly RioPort.com Inc., which was a wholly owned subsidiary, to
sell shares of its preferred stock to third party venture capital and strategic
investors. RioPort is developing an integrated platform for acquiring, managing
and experiencing music and spoken audio programming from the Internet. As a
result of the preferred stock financing, the Company retained a minority
investment in RioPort and accounts for its investment using the equity method.
In addition, in November 1999, the Company received $10.9 million for the sale
of OneStep, LLC to RioPort. In June 2000, RioPort sold additional preferred
stock to third party investors. As part of this financing, the Company invested
an additional $10.7 million in RioPort, maintaining its percentage ownership of
RioPort. In the fourth quarter of 2000, RioPort sold additional preferred stock
to third party investors. As of June 30, 2001, SONICblue held approximately 33%
of RioPort's outstanding stock.

        In November 1999, the Company established a joint venture with VIA to
bring high-performance integrated graphics and core logic chip sets to the
volume OEM desktop and notebook PC markets. The joint venture, S3-VIA, Inc., was
jointly funded, with access to both SONICblue's and VIA's technology as well as
distribution rights for developed products


                                       12


<PAGE>   13
between SONICblue and VIA. SONICblue owns 50.1% of the voting common stock of
S3-VIA and accordingly, SONICblue consolidates the accounts of S3-VIA in its
consolidated financial statements.

        In August 2000, the Company began the shutdown of its Diamond
Multimedia-branded graphics add-in board business. The Company will continue to
supply and support its OEM customers, channel partners and end-users for the
existing line of Diamond Multimedia-branded PC graphics add-in cards, but has
ceased development of follow-on products. The shut-down did not extend to the
Company's professional graphics division, headquartered in Germany, which
continued to develop and market its line of Fire GL graphics accelerators until,
as discussed below, the Company sold its professional graphics division to ATI
Technologies.

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

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

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

        In March 2001, SONICblue signed a definitive agreement to acquire
ReplayTV, Inc., a developer of personal television technology. The acquisition
was completed on August 1, 2001. Under the terms of the agreement, ReplayTV has
become a wholly owned subsidiary of SONICblue and SONICblue will issue an
aggregate of 15.5 million shares of common stock and options and warrants to
purchase shares of SONICblue common stock in exchange for all of ReplayTV's
outstanding equity. In connection with the acquisition of ReplayTV, SONICblue
had made loans to ReplayTV in the amount of $18.4 million as of June 30, 2001.

        In March 2001, SONICblue completed the sale to ATI Technologies, Inc. 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 received $2.7 million in cash and is eligible to receive
further financial consideration of up to $7.3 million, contingent upon the Fire
GL graphics business, as operated by ATI, achieving future performance targets.

        On June 27, 2001, SONICblue completed the acquisition of Sensory Science
Corporation, a developer of consumer electronics products, including dual deck
video cassette player/recorders and DVD players. At closing, each share of
Sensory Science common stock was converted into the right to receive 0.0913 of a
share of SONICblue common stock. As a result of the merger, SONICblue will issue
approximately 1.3 million shares of SONICblue common stock to Sensory Science
stockholders in exchange for the common stock of Sensory Science outstanding on
June 27, 2001. In connection with the proposed acquisition of Sensory Science,
SONICblue had made loans to Sensory Science in the amount of $9.8 million as of
June 27, 2001.

        The purchase price of $20.5 million includes $7.2 million of stock
issued at fair value (fair value being determined as the average price of the
SONICblue at the date the exchange ratio was fixed per the merger agreement),
$0.3 million stock option costs (determined under both the Black-Scholes formula
and in accordance with the merger agreement), cash paid to Sensory Science of
$9.8 million and $3.2 million in estimated expenses of the transaction. The
purchase price was allocated as follows: $(1.6) million to the estimated fair
value of Sensory Science net tangible assets purchased (as of June 27, 2001),
$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, $5.1 million to distribution channel relationships and $13.0
million to goodwill. Goodwill is recorded as a result of consideration paid in
excess of the fair value of net tangible and intangible assets acquired.
Goodwill and identified acquisition related intangible assets are amortized on a
straight-line basis, generally over a five year period. The allocation of the
purchase price to intangibles was based upon management's estimates. The
purchase price and the related allocation is subject to further refinement and
change over the next year.


                                       13


<PAGE>   14
RESULTS OF OPERATIONS

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


<TABLE>
<CAPTION>
                                                         THREE MONTHS ENDED                SIX MONTHS ENDED
                                                               JUNE 30,                         JUNE 30,
                                                     --------------------------        --------------------------
                                                        2001             2000             2001            2000
                                                     ---------        ---------        ---------        ---------
<S>                                                  <C>              <C>              <C>              <C>
Net sales                                                100.0%           100.0%           100.0%           100.0%
Cost of sales                                            328.8             96.3            206.2             93.8
                                                     ---------        ---------        ---------        ---------
Gross margin                                            (228.8)             3.7           (106.2)             6.2

Operating expenses:
    Research and development                              21.8             15.7             21.6             14.1
    Selling, marketing and administrative                115.6             20.2             74.3             19.2
    In-process research and development                    3.0               --              1.1               --
    Restructuring expense and impairment charge          414.2               --            154.0               --
    Amortization of goodwill and intangibles              37.8              8.2             28.1              7.2
                                                     ---------        ---------        ---------        ---------
        Total operating expenses                         592.4             44.0            279.0             40.6
Loss from operations                                    (821.2)           (40.4)          (385.1)           (34.4)

Gain on sale of manufacturing joint venture                 --              5.3               --              5.0
Gain (loss) on UMC investment                           (236.9)              --           (665.0)           295.8
Gain (loss) on other investments                         (70.7)             2.0            (27.0)             2.0
Equity (loss) of investees                                  --             (4.4)            (0.1)            (2.1)
Other income (expense), net                              (13.9)             0.6             (9.1)             0.2
                                                     ---------        ---------        ---------        ---------
Income (loss) before income taxes                      (1142.8)           (36.9)         (1086.4)           266.5
Income tax expense (benefit)                             (83.6)           (10.2)          (269.8)           113.2
                                                     ---------        ---------        ---------        ---------
Net income (loss)                                      (1059.2)%          (26.7)%         (816.6)%          153.3%
                                                     =========        =========        =========        =========
</TABLE>


Net Sales

        The Company's products are used in, and its business is dependent upon,
the PC industry and growth of the Internet. Sales of the Company's products are
primarily in the United States with some sales in Asia and Europe. Net sales
were $29.5 million for the three months ended June 30, 2001, a decrease of 78.3%
from $135.8 million for the three months ended June 30, 2000. Net sales were
$79.4 million for the six months ended June 30, 2001, a decrease of 73.3% from
$297.5 million for the six months ended June 30, 2000. Net sales decreased from
2000 to 2001 due to the exclusion of revenues from the multimedia board business
which was shut down in the third quarter of fiscal 2000, the exclusion of
revenues from the graphics chips business which was transferred to a joint
venture with VIA in January 2001 and the exclusion of revenues from the
professional graphics division which was sold to ATI Technologies in March 2001.
Net sales for the three months ended June 30, 2001 and the six months ended June
30 2001 consisted primarily of the Company's Diamond brand modem, PDA and
communications products, Rio digital audio players, Sensory Science video
products and net sales from the Company's S3-VIA joint venture. Net sales for
the three months ended June 30, 2000 and the six months ended June 30, 2000 were
generated from the sale of the Company's graphics and multimedia accelerators,
connectivity products for the home and products for acquiring, managing and
experiencing music and spoken audio programming from the Internet.

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

        International sales accounted for 33% and 54% of net sales for the three
months ended June 30, 2001 and


                                       14


<PAGE>   15
2000, respectively, excluding the net sales of S3-VIA, Inc. International sales
accounted for 50% and 54% of net sales for the six months ended June 30, 2001
and 2000, respectively, excluding the net sales of S3-VIA, Inc. Approximately
17% and 29% of international sales for the three months ended June 30, 2001 and
2000, respectively, were to affiliates of United States customers, excluding the
net sales of S3-VIA, Inc. Approximately 31% and 27% of international sales for
the six months ended June 30, 2001 and 2000, respectively, were to affiliates of
United States customers, excluding the net sales of S3-VIA, Inc. The Company
expects that export sales will continue to represent a significant portion of
net sales, although there can be no assurances that export sales as a percentage
of net sales will remain at current levels. All sales transactions are
denominated in U.S. dollars.

        Two customers accounted for 12% and 11% of net sales in the three months
ended June 30, 2001, exclusive of sales of S3-VIA, Inc. Two customers accounted
for 23% and 14% of net sales for the three months ended June 30, 2000. Two
customers accounted for 12% and 10% of net sales for the six months ended June
30, 2001, exclusive of sales of S3-VIA, Inc. Two customers accounted for 18% and
10% of net sales for the six months ended June 30, 2000. The Company expects a
significant portion of its future sales to remain concentrated within a limited
number of strategic customers. Sales to any particular customer may fluctuate
significantly from quarter to quarter.

Gross Margin

        The Company had a negative gross margin of 228.8% for the three months
ended June 30, 2001, as compared with a positive gross margin of 3.7% for the
three months ended June 30, 2000. The Company had a negative gross margin of
106.2% for the six months ended June 30, 2001, as compared with a positive gross
margin of 6.2% for the six months ended June 30, 2000. The decrease was
primarily the result of manufacturing costs associated with the exit of the
graphics board and chip businesses as well as write-downs of tooling and
obsolete inventory. Another factor contributing to the decreased gross margin is
the highly competitive pricing pressures in the PC industry and Internet space.

        In the future, the Company's gross margin percentages may be affected by
increased competition and related decreases in the unit average selling prices
particularly with respect to older generation products, timing and volume of
shipments of new products, the availability and cost of products from the
Company's suppliers, changes in the mix of products sold and the extent to which
the Company incurs additional licensing fees.

Research and Development Expenses

        The Company has made and intends to continue to make significant
investments in research and development to remain competitive by developing new
and enhanced products. Research and development expenses were $6.4 million for
the three months ended June 30, 2001, a decrease of $14.9 million from $21.3
million for the three months ended June 30, 2000. Research and development
expenses were $17.1 million for the six months ended June 30, 2001, a decrease
of $24.9 million from $42.0 million for the six months ended June 30, 2000. This
decrease was primarily due to reduction in headcount and related personnel costs
resulting from the shutdown of the Company's multimedia board business and the
transfer of its graphics chips business. The Company intends 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 and fees for professional services, such as legal and
accounting services. Selling, marketing and administrative expenses were $34.1
million for the three months ended June 30, 2001, an increase of $6.6 million
from $27.5 million for the three months ended June 30, 2000. Selling, marketing
and administrative expenses were $59.0 million for the six months ended June 30,
2001, an increase of $1.9 million from $57.1 million for the six months ended
June 30, 2000. Selling, marketing and administrative expenses increased from the
same period in the prior year primarily due to expenses associated with
reorganization and, administering personnel reduction, offset by a reduction in
headcount and related personnel costs resulting from the shutdown of the
Company's multimedia board business and the transfer of its graphics chips
business. As a percentage of revenue, selling, marketing and administrative
expenses increased from 19.2% in 2000 to 74.3% in 2001.

Amortization of Goodwill and Intangibles

        Amortization of goodwill and intangibles increased from $11.1 million
for the three months ended June 30, 2000 to $11.2 million for the three months
ended June 30, 2001. Amortization of goodwill and intangibles increased from
$21.6 million for the six months ended June 30, 2000 to $22.3 million for the
six months ended June 30, 2001. During the three months ended June 30, 2001


                                       15


<PAGE>   16
the Company wrote off approximately $109.1 million of goodwill, primarily
related to the goodwill recorded at the time of the acquisition of Diamond
Multimedia Systems, Inc.

Gain on Sale of Manufacturing Joint Venture

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

        In June 1999, the Company amended its agreement with UMC. Under the
terms of the amended agreement, UMC has agreed to pay the Company, subject to
certain conditions, 1.4 billion New Taiwan Dollars (totaling approximately $37.2
million in cash over the period that the cash was received) and the Company has
agreed to release UMC from contingencies associated with the sale of 80 million
shares of stock of USC in January 1998 (described in the preceding paragraph)
and to grant a license to UMC for 29 patents covering multimedia products and
integrated circuit manufacturing technology for use in products manufactured by
UMC. The Company recognized the gain on this transaction over five fiscal
quarters beginning in the quarter ended June 30, 1999, as payments were
received. For the three months and six months ended June 30, 2000, the gain
recognized on the sale of the stock in USC was $7.3 million and $14.7 million,
respectively. No gain was recognized in the three months and six months ended
June 30, 2001 as payments have ceased under the agreement.

Gain (Loss) on UMC Investment

        In 1995, SONICblue entered into a joint foundry venture with UMC to
build USC, a semiconductor manufacturing facility in Taiwan, R.O.C. In January
2000, USC merged with UMC and, as a result of the merger, SONICblue received 252
million UMC shares in exchange for 252 million USC shares. The Company also
received a 20% stock dividend, or approximately 50.4 million shares of UMC
stock, in April 2000, increasing SONICblue's holdings to approximately 302
million shares of UMC stock. The Company sold 15 million shares of UMC stock in
2000 and 73 million shares in the first six months of 2001 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 classified as restricted because
they are subject to restrictions on their sale that lapse over a three-year
period from the date of the merger. At June 30, 2001, approximately 101 million
shares were subject to restrictions that will lapse in one year or more and are
recorded as a long-term investment at market values as of June 30, 2001. The
unrestricted shares and shares where the restrictions will lapse in one year or
less are recorded as a current asset and are valued at market in accordance with
SFAS 115. The available-for-sale portion of the Company's investment was
marked-to-market through other comprehensive income as required by SFAS 115. The
restricted shares were originally recorded at cost. At December 31, 2000, the
market value of both the short-term and long-term 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 and second quarters 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. There is a great deal of
uncertainty regarding when the semiconductor industry will 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
$62.3 million for the three months and $468.0 million for the six months ended
June 30, 2001 based on the market value at that date. Also, the Company's sale
of 73 million shares of UMC in the first six months of 2001 resulted in a
realized loss of $60 million. As of June 30, 2001, SONICblue's 214 million UMC
shares were worth approximately $285 million, based on the closing price of UMC
shares on the Taiwan Stock Exchange on that date and the U.S. dollar to New
Taiwan Dollar exchange rate prevailing on that date. The 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, 2001 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 will be recorded as expense in
the statement of operations.


                                       16


<PAGE>   17
Gain (Loss) on Other Investments

        In the three months ended June 30, 2001 the Company recognized a loss of
$20.9 million related to the write-down of certain equity investments and in the
three months ended June 30, 2000 the Company recognized a gain of $2.7 million
from the sale of certain non-strategic investments in corporate equity
securities. In the six months ended June 30, 2001 the Company recognized a loss
of $21.5 million primarily related to the write-down of certain other equity
investments. During the six months ended June 30, 2000 the Company recognized a
gain of $5.9 million related to these investments. The downturn in the economy
contributed to the decline in the market value of these securities.

Equity Loss of Investees

        Investments in entities in which the Company does not have control, but
has the ability to exercise significant influence over operating and financial
policies, are accounted for by the equity method. For the three months ended
June 30, 2001, the Company reported no losses from these entities and for the
three months ended June 30, 2000, losses were $6.0 million. For the six months
ended June 30, 2001, the Company's share of losses in these entities was $0.1
million and for the six months ended June 30, 2000 the losses were $6.4 million.
The losses were principally due to the Company's share of losses from RioPort,
Inc.

Other Income (Expense), Net

        Other expense was $4.1 million for the three months ended June 30, 2001,
compared to other income of $0.8 million for the three months ended June 30,
2000. Other expense was $7.2 million for the six months ended June 30, 2001,
compared with other income of $0.7 million for the six months ended June 30,
2000. The increase in other expense was due primarily to interest expense and
bank fees associated with other lines of credit and increased borrowings.

Income Taxes

        The Company's effective tax rate for the three months ended June 30,
2001 and 2000 was 7.3% and 27.6%, respectively. The Company's effective tax rate
for the six months ended June 30, 2001 and 2000 was 24.8% and 42.5%,
respectively. The effective tax rate reflects expected tax payments on the
adjusted taxable income at the federal, state and international statutory rates.

Liquidity and Capital Resources

        Cash used for operating activities was $105.1 million for the six months
ended June 30, 2001 and consisted primarily of the Company's net loss of $648.3
million, which included a non-operating loss on its 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.

        Cash used for operating activities for the six months ended June 30,
2000 was $184.7 million. The Company's net income of $456.0 million for the six
months ended June 30, 2000 included a non-cash gain on UMC investment of $880.2
million, and non operating gains on VIA investment of $5.9 million and the sale
of manufacturing joint venture of $14.7 million. Cash used for operations for
the six months ended June 30, 2000 was unfavorably impacted by increases in
accounts receivable and inventories and decreases in accounts payable and
accrued liabilities and other liabilities. In addition, cash used for operations
for the six months ended June 30, 2000 was favorably impacted by depreciation,
amortization, increases in deferred income taxes and deferred revenue and
decreases in prepaid expenses and other.

        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 acquisitions of ReplayTV and Sensory Science.
Investing activities used cash of $42.4 million for the six months ended June
30, 2000 and consisted primarily of purchases of short-term investments, net,
investments in Number Nine and VIA and purchases of property and equipment,
partially offset by cash received from UMC related to the sale of USC shares,
and the increases in other assets.

        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. Financing activities provided cash of $120.7 million for the six
months ended June 30, 2000. Sales of common stock, including $145.5 million
received from the sale of stock to VIA, was the financing activity generating
cash during the six months ended June 30, 2000 which was offset partially by
repayments of notes payable.


                                       17
<PAGE>   18
Working capital at June 30, 2001 was a deficit of $40.3 million at June 30, 2001
and $161.5 million at December 31, 2000. At June 30, 2001, the Company's
principal sources of liquidity included cash and equivalents of $8.4 million and
$6.4 million in short-term investments. In addition, the company held
unrestricted shares of UMC valued at $151.1 million at June 30, 2001 based upon
then existing New Taiwan dollar to U.S. dollar exchange rates and UMC's market
price on the Taiwan Stock Exchange, of which $106.3 million were pledged to
secure a credit facility. The Company's principle sources of liquidity at
December 31, 2000 included cash and equivalents of $36.6 million and $9.0
million of short-term investments. In addition, the Company held shares of UMC
valued at $228.7 million at December 31, 2000 based upon then existing New
Taiwan dollar to U.S. dollar exchange rates and UMC's market price on the Taiwan
Stock Exchange. As of June 30, 2001, the Company had maximum short-term lines of
credit and bank credit facilities totaling $90.0 million, limited by a borrowing
base determined by specific inventory, receivable and investment balances. The
Company had no unused credit facility or lines of credit available at June 30,
2001.


        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."


Recent Accounting Pronouncements

        In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 141, "Business Combination" ("FAS 141") and
Financial Accounting Standards Board issued Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). FAS 141
eliminates the pooling-of-interests method of accounting for business
combinations except for qualifying business combinations that were initiated
prior to June 1, 2001. FAS 141 further clarifies the criteria to recognize
intangible assets separately form goodwill. The requirements of FAS 141 are
effective for any business combination accounted for by the purchase method that
is completed after June 30, 2001 (i.e., the acquisition date is July 1, 2001 or
thereafter). Under FAS 142, goodwill and indefinite-lived intangible assets are
no longer amortized buy are reviewed annually (or more frequently if impairment
indicators arise) for impairment. Separable intangible assets that are not
deemed to have an indefinite life will continue to be amortized over their
useful lives. We will adopt both statements on January 1, 2002 and are currently
evaluating the impact of these statements. We have not yet quantified the impact
of these statements on our operations. During 2002, we will perform the first of
the required impairment tests of goodwill as of January 1, 2002, and we have not
yet determined what the effect of these tests will be on our earnings and
financial position. Any impairment resulting from our initial application of the
statements will be recorded as a cumulative effect accounting change as of
January 1, 2002.

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

        As a result of the adoption of Statement 133, the Company recognized all
derivative financial instruments, such as foreign exchange contracts, in the
consolidated financial instruments at fair value regardless of the purpose or
the intent for holding the instrument. Changes in the fair value of derivative
financial instruments are either recognized periodically in income or in
stockholders' equity as a component of comprehensive income depending on whether
the derivative financial instrument qualifies for hedging accounting, and if so,
whether it qualifies as a fair value hedge or cash flow hedge. Generally,
changes in fair values of derivatives accounted for as fair value hedges are
recorded in income along with the portions of the changes in the fair values of
the hedged items that relate to the hedged risk(s). Changes in fair values of
derivatives accounted for as cash flow hedges, to the extent they are effective
as hedges, are recorded in other comprehensive income net of deferred taxes.
Changes in fair value of derivatives used as hedges of the net investment in
foreign operations are reported in other comprehensive income as part of the
cumulative translation adjustment. Changes in fair value of derivatives not
qualifying as hedges are reported in income. At June 30, 2001, the Company did
not hold derivative financial instruments, and the adoption of Statement 133 did
not have an impact on the Company's financial statements.


                                       18


<PAGE>   19
FACTORS THAT MAY AFFECT OUR RESULTS

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

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

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

        SONICblue had a net loss of $648.3 million for the six months ended June
30, 2001, primarily resulting from the recognition of an unrealized loss of
$468.3 million and a realized loss of $69.9 million related to the decline in
value of the UMC shares. SONICblue had net income of $312.8 million for the year
ended December 31, 2000, primarily from recognizing a one time gain of $884.2
million on the UMC shares but not as a result of income from operations.
SONICblue had a net loss of $30.8 million for 1999, and SONICblue's sales during
that time consisted of primarily older generation and lower price products that
were sold into markets with significant price competition. With the completion
of the transfer of SONICblue's graphics chips business, SONICblue's ability to
achieve operating profitability depends 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 experienced negative
gross margins in 2000 and in the first six months of 2001 and could continue to
experience negative gross margins. Price competition and declining prices for
consumer goods in the first six months of 2001 contributed to the negative gross
margins. SONICblue cannot assure you that it will be able to achieve operating
profitability. If SONICblue is unable to achieve operating profitability or
incurs future losses and negative cash flow, its stock price would likely
decline.

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

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

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

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

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


                                       19


<PAGE>   20
copies of music from personal collections, or changes in copyright laws, could
diminish the ability of consumers to download music to Rio players. Reductions
in the availability or ease of downloading music from the Internet, or
limitations on copying from personal CDs, could impair the use and sale of
SONICblue's digital audio products.

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

        SONICblue's revenues have historically been dependent on the markets for
graphics/video chips for PCs and on its ability to compete in those markets.
With the completion of the transfer of the graphics chips assets to a joint
venture between VIA and a wholly owned subsidiary of SONICblue, SONICblue's
remaining businesses continue to have significant product concentration.
SONICblue is dependent on the markets for digital audio players, modems, home
networking and other consumer electronics products. SONICblue's business would
be materially harmed if it were unsuccessful in selling digital audio players,
including its Rio players. Historically, over 75% of the net sales of
SONICblue's subsidiary, Diamond, have come from sales of graphics and video
accelerator subsystems. Excluding the graphics board business, the Rio players
have historically accounted for over 90% of the remainder of Diamond's sales. In
2000, Rio players and products accounted for 12.2% of SONICblue's net sales. For
the six months ended June 30, 2001, Rio players and products accounted for a
substantial portion of SONICblue's net sales excluding net sales from S3-VIA,
Inc. A decline in demand or average selling prices for digital audio players,
modems and home networking products would have a material adverse effect on
SONICblue's sales and operating results.

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

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

BECAUSE THE PRICE OF THE UMC SHARES HAS DECLINED SINCE SONICBLUE RECORDED THEIR
CARRYING VALUE, SONICBLUE MAY NEED TO REPORT A LOSS IN OTHER INCOME AND EXPENSE
IF IT DETERMINES THAT THE DECLINE IN THE SEMICONDUCTOR INDUSTRY IS NOT
TEMPORARY. SONICBLUE'S ABILITY TO SELL ITS UMC SHARES IS SUBJECT TO LOCKUP AND
PLEDGE RESTRICTIONS.

        At December 31, 2000, the carrying value of the UMC shares on
SONICblue's consolidated balance sheet was $635.0 million, and the market value
of both SONICblue's short-term and long-term investment in UMC had declined to
$407.2 million. It was determined that the decline from the carrying value at
December 31, 2000 and the original cost basis was related to the downturn in the
semiconductor industry as a whole and was temporary in nature due to the
historically cyclical nature of the industry. Subsequent to year-end, the market
value of the investment in UMC remained significantly below cost. As of June 30,
2001, SONICblue's 214 million UMC shares held as of that date were worth
approximately $285 million, based on the closing price of UMC shares on the
Taiwan Stock Exchange on that date and the U.S. dollar to New Taiwan Dollar
exchange rate prevailing on that date. The downturn in the semiconductor
industry and the economy in general appears to be more severe than previously
anticipated. There is a great deal of uncertainty regarding when the
semiconductor industry will recover from this down cycle. Because SONICblue
concluded that the decline in value was not temporary, it reported an unrealized
loss on the UMC investment of $468.3 million and a realized loss of $59.6
million for the six months ended June 30, 2001. Future fluctuations in the value
of SONICblue's portfolio investments, including the UMC shares, could negatively
impact SONICblue's financial condition.

        In addition, due to Taiwan governmental restrictions, 50% of the initial
UMC shares, or 126 million shares, are subject to lockup restrictions, which
will be released over time beginning in January 2002. A portion of SONICblue's
unrestricted UMC shares is the subject of a pledge agreement to secure bank line
of credit. As a result, SONICblue's ability to sell its UMC shares is limited.


                                       20


<PAGE>   21
THE INFORMATION APPLIANCE MARKET IS NEW AND EVOLVING, AND SONICBLUE'S FRONTPATH
SUBSIDIARY MAY NOT SUCCEED IN DEVELOPING AND BRINGING TO MARKET INFORMATION
APPLIANCES FOR THE HOME AND VERTICAL MARKETS.

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

        A number of companies who have attempted to develop and enter the
information appliance market have not succeeded in bringing products to market
or have discontinued them or scaled back their information appliance divisions.
frontpath's new product, ProGear, has been released in limited quantities but
has not yet been produced or deployed in volume. If frontpath is unable to
obtain manufacturing capacity and develop efficiencies to successfully produce
ProGear in volume, it will be unable to supply information appliances in the
vertical markets. frontpath's development of products for the home depends upon
its ability to successfully manufacture and deploy information appliances in
volume. If the market for information appliances does not develop or develops
more slowly than SONICblue anticipates, or if SONICblue fails to meet the demand
of that market or otherwise fails to achieve market penetration or price
stability for its information appliance products, frontpath will experience
losses that will harm SONICblue's operating results.

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

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

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

        -       inconsistent quality and reliability of broadband service;

        -       lack of interoperability among multiple vendors' network
                equipment;

        -       congestion in service providers' networks; and

        -       inability to meet demands for increasing bandwidth.

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

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

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


                                       21


<PAGE>   22
emergence and growth of the market for SONICblue's products will depend on
improvements being made to the entire Internet infrastructure.

NET SALES FROM SONICBLUE'S JOINT VENTURE, S3-VIA, INC., WILL LIKELY DECLINE IN
THE FUTURE, POTENTIALLY RESULTING IN A DECLINE IN SONICBLUE'S CONSOLIDATED
REVENUES.

        Although SONICblue completed the transfer of its wholly owned graphics
chip business assets to a joint venture between VIA and a wholly owned
subsidiary of SONICblue, in January 2001, SONICblue retained its ownership of
50.1% of the voting common stock of S3-VIA, Inc., a joint venture between
SONICblue and VIA. SONICblue consolidates the accounts of S3-VIA, Inc. in its
financial statements. S3-VIA, Inc. may not develop new technology or products.
As a result, the amount of net sales received by SONICblue through its ownership
interest in S3-VIA, Inc. is expected to decline as its product offerings age and
become obsolete. Because SONICblue consolidates S3-VIA, Inc.'s accounts into its
financial statements, a decline in S3-VIA, Inc.'s net sales will reduce
SONICblue's revenues.

        In addition, SONICblue may reduce or completely eliminate its holdings
in S3-VIA, Inc. as part of its strategy to exit the graphics business. If
SONICblue's interest in S3-VIA, Inc. falls below 50% of the voting common stock,
SONICblue will not consolidate S3-VIA Inc.'s accounts in its financial
statements and SONICblue revenues will be reduced.

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

        The investment agreement with VIA provides that,upon occurrence of
certain events,SONICblue will pay liquidated damages,subject to a maximum
damages cap. Despite the cap, liquidated damages payments could harm SONICblue's
financial condition or results of operations. In addition, SONICblue will
receive earn-out payments only if the new venture meets aggressive profitability
goals specified in the joint venture agreement. There can be no assurance that
the joint venture will be able to meet these profitability goals.

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

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

        -       attracting, integrating and retaining key employees;

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

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

        -       consolidation of geographically dispersed manufacturing and
                distribution facilities;

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

        -       integration of various functions and groups of employees.

        SONICblue may not successfully address these challenges. SONICblue's
future operating results will depend in large measure on its ability to
implement operating, manufacturing and financial procedures and controls,
improve communication and coordination among the different operating functions,
integrate functions such as sales, procurement and operations, strengthen
management information and telecommunications systems, and continue to hire
additional qualified personnel in key areas. SONICblue may be unable to manage
these activities and implement these additional procedures, controls and systems
successfully. Any failure to do so could cause SONICblue's short-term and
long-term operating results to suffer.


                                       22


<PAGE>   23
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, Asia and Europe in particular, that could affect
                the timing of customer orders and capital spending and result in
                order cancellations or rescheduling.

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

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


                                       23


<PAGE>   24
        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 digital audio and other consumer
electronic products is strongest during the fourth quarter of each year and is
generally slower in the period from March through August. This seasonality may
become more pronounced and material in the future to the extent that:

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

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

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

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

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

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

        -       performance and quality;

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

        -       access to customers and distribution channels;

        -       reputation for quality and strength of brand;

        -       manufacturing capabilities and cost of manufacturing;

        -       price;

        -       product support; and

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

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


                                       24


<PAGE>   25
        In some markets where SONICblue is a relatively new entrant, such as
modems, home networking, sound cards and consumer electronics, including digital
audio or Internet music players and Internet appliances, it faces dominant
competitors that include Compaq (Internet appliances and digital audio players),
3Com (home networking and modems), Creative Technology under the name Creative
Labs (modems and digital audio players), Handspring (personal digital
assistants, or PDAs, and digital audio player add-ons to PDAs), Gateway (home
networking, home network digital audio players and Internet appliances), Intel
(home networking and digital audio players), Motorola (Internet appliances and
handheld consumer electronics), Palm (PDAs), Samsung (digital audio players,
digital audio player mobile telephones and Internet appliances), Sony (consumer
electronic music, digital audio players and a recently announced Internet
appliance) and Thompson Multimedia (digital audio players). Some of SONICblue's
products face a variety of competitive sources. For example, digital audio
players compete against traditional stereos and CD players, and frontpath
information appliances face competition from manufacturers of stand alone
Internet appliances, wireless portable Internet appliances, PDAs, and
manufacturers of PCs. In addition, the markets in which SONICblue competes are
expected to become increasingly competitive as PC products support increasingly
more robust multimedia functions and companies that previously supplied products
providing distinct functions (for example, companies today primarily in the
sound, modem, microprocessor or motherboard markets) emerge as competitors
across broader or more integrated product categories.

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

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

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

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

        Historically, the gross profit margins on the products of Diamond were
lower than the margins on SONICblue's products. As a result of the Diamond
merger, SONICblue's average gross margins have been lower than they were prior
to the Diamond merger, thereby decreasing SONICblue's average gross margins. In
addition, because the products remaining in SONICblue's refocused business
include Diamond products such as the Rio players, SONICblue's average gross
margins will likely be lower after the transfer of the graphics chips assets to
S3 Graphics, the joint venture between VIA and a wholly owned subsidiary of
SONICblue than prior to the transfer.

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


                                       25


<PAGE>   26
        The markets for which SONICblue's products are designed are intensely
competitive and are characterized by rapidly changing technology, evolving
industry standards and short product life cycles. For example, the life cycles
of the Rio audio players typically range from 12 to 18 months. If SONICblue
fails to introduce new products successfully within a given time frame,
SONICblue could lose revenues and market share. Further, continued failure to
develop, introduce and market competitive new products that meet customer
demands on time could also damage SONICblue's brand name, reputation and
relationships with its customers and cause longer-term harm to its financial
condition. SONICblue may not successfully enter the various product markets that
it identifies. In addition, the sale of new products may not become significant
or profitable. To succeed in this environment, SONICblue must anticipate the
features and functionality that customers will demand. SONICblue must then
incorporate those features and functionality into products that meet the design,
performance, quality and pricing requirements of the digital media and consumer
electronics markets in which it competes and the timing requirements of retail
selling seasons. SONICblue believes this will require expenditures for research
and development in the future consistent with its historical research and
development expenditures related to its current refocused businesses. SONICblue
has in the past experienced delays in completing the development and
introduction of new products and may experience similar delays in the future. In
the past, SONICblue's business was seriously harmed when it developed products
that failed to achieve significant market acceptance and therefore was unable to
compete successfully in its markets. This type of failure could occur again in
the future.

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

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

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

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

        Also, in an effort to avoid actual or perceived component shortages,
SONICblue may purchase more of certain components than it may otherwise require.
Excess inventory resulting from over-purchases, obsolescence or a decline in the
market value of such inventory could result in inventory write-offs, which would
have a negative effect on SONICblue's financial results as happened in the first
and second quarters of 1998. Although these over-purchases related to the
graphics chips business, they could occur with respect to other products
including those of S3-VIA, Inc., a joint venture that SONICblue and VIA
established in November 1999 to design, produce and market integrated graphics
and core logic chip sets. Similarly, prior to SONICblue's acquisition of
Diamond, Diamond's perception of component shortages caused Diamond to
over-purchase certain components and pay surcharges for components that
subsequently declined in value in the second, third and fourth quarters of 1998.
In addition, SONICblue's inventory sell-offs or sell-offs by its competitors
could trigger channel price protection charges, further reducing its gross
margins and profitability.


                                       26


<PAGE>   27
IF A NEW STORAGE MEDIUM BECOMES THE INDUSTRY STANDARD FOR DIGITAL AUDIO AND
SONICBLUE IS UNABLE TO ADAPT ITS PRODUCTS, SONICBLUE MAY NOT BE ABLE TO COMPETE.

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

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

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

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

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

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

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

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


                                       27


<PAGE>   28
manufacturing capacity or offer other incentives. As SONICblue develops new
products, such as its frontpath information appliances, it will require
manufacturing capacity to produce quantities to meet market demand. If SONICblue
is unable to obtain and maintain access to high quality manufacturing capacity
for its existing and future products, it will not be able to fill distributor or
customer orders, and its revenues will decline.

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

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

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

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

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

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

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


                                       28


<PAGE>   29
adverse impact on operating results. Any estimates, reserves or accruals may be
insufficient and any future price reductions may seriously harm its operating
results.

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

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

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

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

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

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

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


                                       29


<PAGE>   30
        Litigation by or against SONICblue could result in significant expense
and could divert the efforts of its technical and management personnel,
regardless of the outcome of such litigation. However, even if claims do not
have merit, SONICblue may be required to dedicate significant management time
and expense to defending itself if it is directly sued, or assisting its
customers in their defense of these or other infringement claims pursuant to
indemnity agreements. This could have a negative effect on SONICblue's financial
results.

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

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

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

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

SONICBLUE HAS SIGNIFICANT EXPOSURE TO INTERNATIONAL MARKETS.

        Export sales accounted for 56%, 70% and 89% of net sales in 2000, 1999
and 1998, respectively, and 50% of net sales for the six month ended June 30,
2001, excluding the net sales of S3-VIA, Inc. Approximately 33% of export sales
in 2000 and 31% of export sales in the six months ended June 30, 2001, excluding
the net sales of S3-VIA, Inc., were to affiliates of United States customers. In
addition, a substantial proportion of SONICblue's products are manufactured,
assembled and tested by independent third parties in Asia. As a result,
SONICblue is subject to the risks of conducting business internationally,
including:

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

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

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

        -       tariffs and other trade barriers and restrictions;

        -       potentially longer payment cycles;

        -       greater difficulty in accounts receivable collection;

        -       potentially adverse tax treatment; and

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

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


                                       30


<PAGE>   31
SONICBLUE HAS A SIGNIFICANT LEVEL OF DEBT, WHICH MAY HARM ITS ABILITY TO OBTAIN
ADDITIONAL FINANCING OR ADVERSELY AFFECT ITS LIQUIDITY.

        At June 30, 2001, SONICblue had total debt and other long-term
liabilities outstanding of $173 million, including a $52 million from a line of
credit secured by SONICblue's shares of UMC. Foreclosure on the UMC shares would
harm SONICblue's financial condition. The degree to which SONICblue is leveraged
could harm its ability to obtain additional financing for working capital or
other purposes and could make SONICblue more vulnerable to economic downturns
and competitive pressures. SONICblue's significant leverage could also adversely
affect its liquidity, as a substantial portion of available cash from operations
may have to be applied to meet debt service requirements. In the event of a cash
shortfall, SONICblue could be forced to reduce other expenditures to be able to
meet such debt service requirements.

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

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

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

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

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

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

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


                                       31


<PAGE>   32
        SONICblue has also been defending several putative class action lawsuits
naming Diamond, which were filed in June and July 1996 and June 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain former executive officers and
directors of Diamond are also named as defendants. The plaintiffs purport to
represent a class of all persons who purchased Diamond's common stock between
October 18, 1995 and June 20, 1996, or the Class Period. The complaints allege
claims under the federal securities laws and California law. The plaintiffs
allege that Diamond and the other defendants made various material
misrepresentations and omissions during the Class Period. The complaints do not
specify the amount of damages sought. On March 24, 2000, the District Court for
the Northern District of California dismissed the federal action without
prejudice. The parties have tentatively agreed to settle this matter, subject to
final documentation and court approval, for a payment of $15.0 million.
SONICblue funded $4.5 million of the settlement on November 1, 2000. SONICblue
previously accrued this amount in connection with the merger with Diamond.
SONICblue believes that Diamond's insurance covers the remaining $10.5 million
of the settlement and Diamond's insurers have funded that amount into the
settlement, although one of these insurers has served a notice of arbitration
disputing its obligation to pay $3 million of the $10.5 million.

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Investment Portfolio

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

        The table below summarizes the Company's investment portfolio.


<TABLE>
<CAPTION>
                                        Fair Value
                                        ----------
                                      (In thousands,
                                   except interest rates)
<S>                                <C>
At June 30, 2001:
Cash and equivalents .........      $         8,394
Weighted average interest rate                 3.59%
Short-term investments .......      $         6,383
Weighted average interest rate                 5.22%
Total portfolio ..............      $        14,777
Weighted average interest rate                 4.29%

At June 30, 2000:
Cash and equivalents .........      $        24,288
Weighted average interest rate                 5.01%
Short-term investments .......      $        26,150
Weighted average interest rate                 6.48%
Total portfolio ..............      $        50,438
Weighted average interest rate                 5.38%
</TABLE>


        A hypothetical 10% change in market interest rates would not have a
material effect on the Company's operations or cash flows.


                                       32


<PAGE>   33
Convertible Subordinated Notes

        In September 1996, the Company completed a private placement of $103.5
million aggregate principal amount of convertible subordinated notes. The notes
mature in 2003. Interest is payable semi-annually at 5 3/4% per annum. The notes
are convertible at the option of the note holders into the Company's common
stock at an initial conversion price of $19.22 per share, subject to adjustment.
During 2000, $0.2 million in notes were converted into common stock. Beginning
in October 1999, the notes became redeemable at the option of the Company at an
initial redemption price of 102% of the principal amount. The fair value of the
convertible subordinated notes at June 30, 2001 and 2000 was approximately $64.8
million and $117.1 million, respectively. A hypothetical 10% change in market
interest rates would not have a material adverse effect on the Company's
operations, cash flows or the fair value of the convertible subordinated notes.

Impact of Foreign Currency Rate Changes

        The Company invoices its customers in US dollars for all products. The
Company is exposed to foreign exchange rate fluctuations as the financial
results of its foreign subsidiaries are translated into US 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.

        The effect of foreign exchange rate fluctuations on the Company's
financial statements for the six months ended June 30, 2001 and 2000 was not
material. Since foreign currency exposure increases as intercompany receivables
grow, from time to time the Company uses foreign exchange forward contracts as a
means for hedging these balances. As of June 30, 2001, the Company held no
exchange contracts.



PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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

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

        SONICblue has also been defending several putative class action lawsuits
naming Diamond, which were filed in June and July 1996 and June 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain former executive officers and
directors of Diamond are also named as defendants. The plaintiffs purport to
represent a class of all persons who purchased Diamond's common stock between
October 18, 1995 and June 20, 1996, or the Class Period. The complaints allege
claims under the federal securities laws and California law. The plaintiffs
allege that Diamond and the


                                       33


<PAGE>   34
other defendants made various material misrepresentations and omissions during
the Class Period. The complaints do not specify the amount of damages sought. On
March 24, 2000, the District Court for the Northern District of California
dismissed the federal action without prejudice. The parties have tentatively
agreed to settle this matter, subject to final documentation and court approval,
for a payment of $15.0 million. SONICblue funded $4.5 million of the settlement
on November 1, 2000. SONICblue previously accrued this amount in connection with
the merger with Diamond. SONICblue believes that Diamond's insurance covers the
remaining $10.5 million of the settlement; Diamond's insurers have funded that
amount into the settlement, although one of these insurers has served a notice
of arbitration disputing its obligation to pay $3 million of the $10.5 million.

        Sega Corporation initiated a claim for arbitration in Tokyo, Japan
against Diamond in December 1998. The claim, which arose out of an agreement
entered into between Sega and Diamond in September 1995, in which Sega agreed to
provide Diamond with Sega game software that Diamond would bundle with its 3-D
graphics board, "The Edge," was settled in March 2001.

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

        On January 6, 2000, PhoneTel Communications, Inc. filed a complaint for
patent infringement against a group of defendants, including Diamond, in the
United States District Court for the Northern District of Texas. The settlement
of this lawsuit was effective in April 2001.

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


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

(a) The Annual Meeting of Stockholders was held on May 23, 2001.

(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.


<TABLE>
<CAPTION>
                                      Votes For      Withheld
                                      ---------      --------
<S>                                  <C>             <C>
Kenneth F. Potashner                 60,115,722      13,337,103
Terry N. Holdt                       72,366,192       1,086,633
Robert P. Lee                        72,366,484       1,086,341
Carmelo J. Santoro                   72,358,092       1,094,733
James T. Schraith                    72,349,870       1,102,955
</TABLE>


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


<TABLE>
<CAPTION>
Votes For     Against       Abstain
---------     -------       -------
<S>           <C>           <C>
73,170,405    213,026       69,394
</TABLE>


                                       34


<PAGE>   35
Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits:


<TABLE>
<CAPTION>
   Exhibit No.  Description
   -----------  -----------
<S>             <C>
     3(ii).1    Amended and Restated Bylaws.

     10.1       Employment Agreement between Registrant and Kenneth F. Potashner
                dated June 21, 2001.

     10.2       Amendment, dated May 9, 2001, to Credit Agreement dated November 9,
                2000 between the Registrant and Chinatrust Commercial Bank.

     10.3       Promissory Noted dated May 9, 2001 by the Registrant in favor of
                Chinatrust Commercial Bank.

     10.4       Amendment, dated May 9, 2001, to Pledge Agreement dated November 9,
                2000 between the Registrant and Chinatrust Commercial Bank.
</TABLE>


(b) Reports on Form 8-K:

        The Company did not file any current reports on Form 8-K during the
quarter ended June 30, 2001.



                                   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)


Date: August 13, 2001                      /s/ JOHN TODD
                       ---------------------------------------------------------
                                             JOHN TODD
                            Senior Vice President, Chief Financial Officer
                                    and Chief Operating Officer
                       (Duly authorized officer and principal financial officer)


                                       35


<PAGE>   36
                                  EXHIBIT INDEX




<TABLE>
<CAPTION>
   Exhibit No.  Description
   -----------  -----------
<S>             <C>
     3(ii).1    Amended and Restated Bylaws.

     10.1       Employment Agreement between Registrant and Kenneth F. Potashner
                dated June 21, 2001.

     10.2       Amendment, dated May 9, 2001, to Credit Agreement dated November 9,
                2000 between the Registrant and Chinatrust Commercial Bank.

     10.3       Promissory Noted dated May 9, 2001 by the Registrant in favor of
                Chinatrust Commercial Bank.

     10.4       Amendment, dated May 9, 2001, to Pledge Agreement dated November 9,
                2000 between the Registrant and Chinatrust Commercial Bank.
</TABLE>


                                       36