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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended June 30, 2004



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 0-28450



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Netopia, Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 94-3033136                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



6001 Shellmound
Street, 4thFloor

Emeryville, California 94608

(Address of principal executive offices, including Zip Code)



(510) 420-7400

(Registrants telephone number, including area code)



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Indicate by
check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 ̈



Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x



As of January 28, 2005, there were 24,899,119 shares of the Registrants common stock outstanding.



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##### Table of Contents

NETOPIA, INC.

Form 10-Q

Table of Contents



|                              |  |                                                                                                                      |  |     
|----------------------------- |  | -------------------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                                      |  | Page
|PART I.
FINANCIAL INFORMATION |  |                                                                                                                     
|                              |  |                                                                                                                     
|Item 1.                       |  | Unaudited Condensed Consolidated Financial Statements                                                                |  | 1   
|                              |  |                                                                                                                     
|                              |  | Unaudited condensed consolidated balance sheets at June 30, 2004 and September 30, 2003                              |  | 1   
|                              |  |                                                                                                                     
|                              |  | Unaudited condensed consolidated statements of operations for the three and nine months ended June 30, 2004 and 2003 |  | 2   
|                              |  |                                                                                                                     
|                              |  | Unaudited condensed consolidated statements of cash flows for the nine months ended June 30, 2004 and 2003           |  | 3   
|                              |  |                                                                                                                     
|                              |  | Notes to unaudited condensed consolidated financial statements                                                       |  | 4   
|                              |  |                                                                                                                     
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                |  | 22  
|                              |  |                                                                                                                     
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                           |  | 41  
|                              |  |                                                                                                                     
|Item 4.                       |  | Controls and Procedures                                                                                              |  | 43  
|                              | 
|PART II.
OTHER INFORMATION    |  |                                                                                                                     
|                              |  |                                                                                                                     
|Item 1.                       |  | Legal Proceedings                                                                                                    |  | 45  
|                              |  |                                                                                                                     
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                                     |  | 46  
|                              | 
|Signatures                    |  | 47                                                                                                                  
|                              | 
|Certifications                |  |                                                                                                                     



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##### Table of Contents

PART I  FINANCIAL INFORMATION



Concurrent with the filing of this report on Form 10-Q, we are filing with the Securities and Exchange Commission (SEC) our Annual Report on Form 10-K for the fiscal year ended September 30, 2004 (the 2004 10-K).
The 2004 10-K amends our Annual Reports on Form 10-K previously filed for the fiscal years ended September 30, 2003 and September 30, 2002, and our previously filed Form 10-Qs for the fiscal quarters ended March 31, 2004 and December 31, 2003, to
reflect the restatements of our consolidated financial statements for all such previously reported periods. This report on Form 10-Q should be read in conjunction with the 2004 10-K, in which we explain the restatements of our consolidated financial
statements.



ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



NETOPIA, INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Balance Sheets



|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | -------- | - | ------------------ | - | -------- | -
|                                                                                                                                                                            |  | June 30,2004   |          |   | September 30,2003* |  
|                                                                                                                                                                            |  | (in thousands) |         
|Assets                                                                                                                                                                      |  |                |          |   |                    |   |          |  
|Current assets:                                                                                                                                                             |  |                |          |   |                    |   |          |  
|Cash and cash equivalents                                                                                                                                                   |  | $              | 23,535   |   |                    | $ | 22,208   |  
|Trade accounts receivable less allowance for doubtful accounts and returns of $112 and $190 at June 30, 2004 and September 30, 2003,
respectively                           |  |                | 16,296   |   |                    |   | 16,062   |  
|Inventories                                                                                                                                                                 |  |                | 8,946    |   |                    |   | 5,738    |  
|Prepaid expenses and other current assets                                                                                                                                   |  |                | 919      |   |                    |   | 899      |  
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|Total current assets                                                                                                                                                        |  |                | 49,696   |   |                    |   | 44,907   |  
|Furniture, fixtures and equipment, net                                                                                                                                      |  |                | 3,062    |   |                    |   | 3,740    |  
|Acquired technology and other intangible assets, net                                                                                                                        |  |                | 4,428    |   |                    |   | 5,251    |  
|Goodwill                                                                                                                                                                    |  |                | 2,133    |   |                    |   | 984      |  
|Long-term investments                                                                                                                                                       |  |                | 1,032    |   |                    |   | 1,032    |  
|Deposits and other assets                                                                                                                                                   |  |                | 1,032    |   |                    |   | 1,105    |  
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|TOTAL ASSETS                                                                                                                                                                |  | $              | 61,383   |   |                    | $ | 57,019   |  
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|Liabilities and Stockholders Equity                                                                                                                                        |  |                |          |   |                    |   |          |  
|Current liabilities:                                                                                                                                                        |  |                |          |   |                    |   |          |  
|Accounts payable                                                                                                                                                            |  | $              | 9,479    |   |                    | $ | 11,222   |  
|Accrued compensation                                                                                                                                                        |  |                | 2,453    |   |                    |   | 1,930    |  
|Accrued liabilities                                                                                                                                                         |  |                | 1,027    |   |                    |   | 1,583    |  
|Deferred revenue                                                                                                                                                            |  |                | 1,552    |   |                    |   | 1,666    |  
|Current portion of borrowings under term loans                                                                                                                              |  |                | 167      |   |                    |   | 250      |  
|Other current liabilities                                                                                                                                                   |  |                | 148      |   |                    |   | 113      |  
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|Total current liabilities                                                                                                                                                   |  |                | 14,826   |   |                    |   | 16,764   |  
|Long-term liabilities:                                                                                                                                                      |  |                |          |   |                    |   |          |  
|Borrowings under term loans                                                                                                                                                 |  |                |         |   |                    |   | 104      |  
|Other long-term liabilities                                                                                                                                                 |  |                | 353      |   |                    |   | 328      |  
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|Total liabilities                                                                                                                                                           |  |                | 15,179   |   |                    |   | 17,196   |  
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|Stockholders equity:                                                                                                                                                       |  |                |          |   |                    |   |          |  
|Common stock: $0.001 par value, 50,000,000 shares authorized; 24,053,827 and 21,631,832 shares issued and outstanding at June 30, 2004 and
September 30, 2003, respectively |  |                | 24       |   |                    |   | 22       |  
|Additional paid-in capital                                                                                                                                                  |  |                | 165,243  |   |                    |   | 156,132  |  
|Accumulated other comprehensive (loss)                                                                                                                                      |  |                | (8       | ) |                    |   |         |  
|Accumulated deficit                                                                                                                                                         |  |                | (119,055 | ) |                    |   | (116,331 | )
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|Total stockholders equity                                                                                                                                                  |  |                | 46,204   |   |                    |   | 39,823   |  
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                  |  | $              | 61,383   |   |                    | $ | 57,019   |  
|                                                                                                                                                                            |  |                |          |   |                    |   |          |  

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|* | Derived from the restated audited consolidated balance sheet dated September 30, 2003 included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2004.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



See accompanying notes to unaudited condensed
consolidated financial statements.



Page 1



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##### Table of Contents

NETOPIA, INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Operations



|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|--------------------------------------------------- |  | ---------------------------------------- | ------ | - | -------------------------- | - | ------ | --------------- |  | - | --------------- | - |  | - | ------ | -
|                                                    |  | Three Months Ended June 30,              |        |   | Nine Months Ended June 30, |  
|                                                    |  | 2004                                     |        |   | 2003 (Restated)            |   |        | 2004 (Restated) |  |   | 2003 (Restated) |  
|                                                    |  | (in thousands, except per share amounts) |       
|REVENUES:                                           |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Broadband equipment                                 |  | $                                        | 21,891 |   |                            | $ | 17,718 |                 |  | $ | 63,426          |   |  | $ | 46,771 |  
|Broadband software and services                     |  |                                          | 3,543  |   |                            |   | 4,114  |                 |  |   | 12,074          |   |  |   | 13,233 |  
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Total revenues                                      |  |                                          | 25,434 |   |                            |   | 21,832 |                 |  |   | 75,500          |   |  |   | 60,004 |  
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|COST OF REVENUES:                                   |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Broadband equipment                                 |  |                                          | 16,757 |   |                            |   | 12,808 |                 |  |   | 45,780          |   |  |   | 34,671 |  
|Broadband software and services                     |  |                                          | 267    |   |                            |   | 316    |                 |  |   | 706             |   |  |   | 1,090  |  
|Amortization of acquired technology                 |  |                                          | 300    |   |                            |   | 288    |                 |  |   | 900             |   |  |   | 864    |  
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Total cost of revenues                              |  |                                          | 17,324 |   |                            |   | 13,412 |                 |  |   | 47,386          |   |  |   | 36,625 |  
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|GROSS PROFIT                                        |  |                                          | 8,110  |   |                            |   | 8,420  |                 |  |   | 28,114          |   |  |   | 23,379 |  
|                                                    |  |                                          |        |  
|OPERATING EXPENSES:                                 |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Research and development                            |  |                                          | 3,846  |   |                            |   | 3,764  |                 |  |   | 11,854          |   |  |   | 11,758 |  
|Research and development project cancellation costs |  |                                          |       |   |                            |   |       |                 |  |   |                |   |  |   | 606    |  
|Selling and marketing                               |  |                                          | 5,199  |   |                            |   | 4,855  |                 |  |   | 15,262          |   |  |   | 15,265 |  
|General and administrative                          |  |                                          | 1,184  |   |                            |   | 961    |                 |  |   | 3,591           |   |  |   | 3,464  |  
|Amortization of intangible assets                   |  |                                          | 86     |   |                            |   | 86     |                 |  |   | 259             |   |  |   | 258    |  
|Restructuring costs                                 |  |                                          |       |   |                            |   | 130    |                 |  |   |                |   |  |   | 472    |  
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Total operating expenses                            |  |                                          | 10,315 |   |                            |   | 9,796  |                 |  |   | 30,966          |   |  |   | 31,823 |  
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|OPERATING LOSS                                      |  |                                          | (2,205 | ) |                            |   | (1,376 | )               |  |   | (2,852          | ) |  |   | (8,444 | )
|                                                    |  |                                          |        |  
|Other income (loss), net                            |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Loss on impaired securities                         |  |                                          |       |   |                            |   |       |                 |  |   |                |   |  |   | (457   | )
|Other income (expense), net                         |  |                                          | (52    | ) |                            |   | (3     | )               |  |   | 193             |   |  |   | (15    | )
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Other income (loss), net                            |  |                                          | (52    | ) |                            |   | (3     | )               |  |   | 193             |   |  |   | (472   | )
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Income (loss) before income taxes                   |  |                                          | (2,257 | ) |                            |   | (1,379 | )               |  |   | (2,659          | ) |  |   | (8,916 | )
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Provision for income taxes                          |  |                                          | (19    | ) |                            |   |       |                 |  |   | (65             | ) |  |   |       |  
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|NET LOSS                                            |  | $                                        | (2,276 | ) |                            | $ | (1,379 | )               |  | $ | (2,724          | ) |  | $ | (8,916 | )
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Per share data, net loss:                           |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Basic and diluted net loss per share                |  | $                                        | (0.09  | ) |                            | $ | (0.07  | )               |  | $ | (0.12           | ) |  | $ | (0.47  | )
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  
|Shares used in the per share calculations           |  |                                          | 24,033 |   |                            |   | 19,370 |                 |  |   | 23,247          |   |  |   | 19,059 |  
|                                                    |  |                                          |        |   |                            |   |        |                 |  |   |                 |   |  |   |        |  



See accompanying notes
to unaudited condensed consolidated financial statements.



Page 2



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##### Table of Contents

NETOPIA, INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows



|                                                                                          |  |                |        |   |                 |   |        |  
|----------------------------------------------------------------------------------------- |  | -------------- | ------ | - | --------------- | - | ------ | -
|Nine months ended June 30,                                                                |  | 2004           |        |   | 2003 (Restated) |  
|                                                                                          |  | (in thousands) |       
|Cash flows from operating activities:                                                     |  |                |        |   |                 |   |        |  
|Net income (loss)                                                                         |  | $              | (2,724 | ) |                 | $ | (8,916 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                |        |   |                 |   |        |  
|Depreciation and amortization                                                             |  |                | 3,344  |   |                 |   | 4,257  |  
|Loss on impaired securities                                                               |  |                |       |   |                 |   | 457    |  
|(Capitalization)/Write-off of capitalized software development costs                      |  |                |       |   |                 |   | 273    |  
|Changes in allowance for doubtful accounts and returns on                                 |  |                |        |   |                 |   |        |  
|Accounts receivable                                                                       |  |                | (79    | ) |                 |   | (376   | )
|Changes in operating assets and liabilities:                                              |  |                |        |   |                 |   |        |  
|Trade accounts receivable                                                                 |  |                | (155   | ) |                 |   | (4,901 | )
|Inventory                                                                                 |  |                | (3,208 | ) |                 |   | 1,834  |  
|Prepaid expenses and other current assets                                                 |  |                | (20    | ) |                 |   | 202    |  
|Deposits and other assets                                                                 |  |                | 72     |   |                 |   | (752   | )
|Accounts payable and accrued liabilities                                                  |  |                | (1,220 | ) |                 |   | 2,583  |  
|Deferred revenue                                                                          |  |                | (114   | ) |                 |   | (713   | )
|Other liabilities                                                                         |  |                | (504   | ) |                 |   | 80     |  
|                                                                                          |  |                |        |   |                 |   |        |  
|Net cash used in operating activities                                                     |  |                | (4,608 | ) |                 |   | (5,972 | )
|                                                                                          |  |                |        |   |                 |   |        |  
|Cash flows from investing activities:                                                     |  |                |        |   |                 |   |        |  
|Purchase of long-term investments                                                         |  |                |       |   |                 |   | (26    | )
|Purchase of furniture, fixtures and equipment                                             |  |                | (1,296 | ) |                 |   | (1,131 | )
|Acquisition of business                                                                   |  |                | (146   | ) |                 |   |       |  
|Capitalization of software development costs                                              |  |                |       |   |                 |   | (144   | )
|Acquisition of intangibles                                                                |  |                | (300   | ) |                 |   |       |  
|                                                                                          |  |                |        |   |                 |   |        |  
|Net cash used in investing activities                                                     |  |                | (1,742 | ) |                 |   | (1,301 | )
|                                                                                          |  |                |        |   |                 |   |        |  
|Cash flows from financing activities:                                                     |  |                |        |   |                 |   |        |  
|Borrowings under credit facility                                                          |  |                |       |   |                 |   | 4,489  |  
|Payments under term loans                                                                 |  |                | (188   | ) |                 |   |       |  
|Proceeds from the issuance of common stock                                                |  |                | 7,865  |   |                 |   | 870    |  
|                                                                                          |  |                |        |   |                 |   |        |  
|Net cash provided by financing activities                                                 |  |                | 7,677  |   |                 |   | 5,359  |  
|                                                                                          |  |                |        |   |                 |   |        |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                | 1,327  |   |                 |   | (1,914 | )
|Cash and cash equivalents, beginning of period                                            |  |                | 22,208 |   |                 |   | 25,022 |  
|                                                                                          |  |                |        |   |                 |   |        |  
|Cash and cash equivalents, end of period                                                  |  | $              | 23,535 |   |                 | $ | 23,108 |  



See accompanying notes
to unaudited condensed consolidated financial statements.



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##### Table of Contents

NETOPIA, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements



(1) The Company



We develop, market and support broadband and wireless (Wi-Fi) products and services that
enable our carrier and service provider customers to simplify and enhance the delivery of broadband services to their residential and business-class customers. Our product and service offerings enable carriers and broadband service providers to (i)
deliver to their customers feature-rich broadband modems, routers and gateways, (ii) utilize software that allows remote management of equipment located at their customers premises, and (iii) provide value-added services to enhance revenue
generation and reduce support costs. Our broadband modems, routers and gateways are installed by the customers of carrier and broadband service providers to obtain high-speed, always-on access to the Internet. Our digital subscriber line (DSL) and
other broadband gateways are often bundled with virtual private networking (or VPN) capabilities that allow more secure communications over the Internet, firewall protection, parental controls, hot spot access, Web content filtering, combined VoIP
and data services, hosting of web sites that we call eSites, and hosting of web stores that we call eStores. Our Netopia Broadband Server (NBBS) software platform enables remote support and management of installed broadband gateways and centralized
service provisioning for value-added broadband services such as parental controls or hot spot access. This software platform allows carriers and broadband service providers to provide support to their customers on a remote basis and can reduce the
cost of installation and broadband service provisioning over the lifetime of the customer. We also offer Timbuktu and eCare software products for enterprise help desk customers and IT organizations. These products allow help desks to provide support
on a remote basis when computer users experience problems or require additional software upgrades with their desktop or laptop computers.



(2) Basis of Presentation



The accompanying unaudited condensed consolidated financial statements included in this Form 10-Q have been prepared pursuant to the rules and regulations of the SEC.
Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations. The interim
financial statements are unaudited, but reflect all adjustments that are, in the opinion of management, necessary to fairly present a fair statement of results for the interim periods presented. The results of operations for the interim periods
reported below do not necessarily indicate the results expected for the full fiscal year or for any future period.



These condensed consolidated financial statements should be read in conjunction with the Companys condensed consolidated financial statements and related footnotes
thereto in the Companys Annual Report on Form 10-K for the fiscal year ended September 30, 2004. The 2004 10-K amends our Annual Reports on Form 10-K previously filed for the fiscal years ended September 30, 2003 and September 30, 2002, and
our previously filed Form 10-Qs for the fiscal quarters ended March 31, 2004 and December 31, 2003, to reflect the restatements of our consolidated financial statements for all such previously reported periods. This report on Form 10-Q should be
read in conjunction with the 2004 10-K, in which we explain the restatements of our consolidated financial statements. The 2004 10-K also includes more current information regarding the restatement of our financial statements, the related SEC
investigation and private securities and derivative litigation, and a discussion of subsequent events and anticipated trends.



Summary of Significant Accounting Policies



During the three months ended March 31, 2004, we adopted a new significant accounting policy, which was not included in our Annual Report on Form 10-K for the fiscal year
ended September 30, 2003.



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##### Table of Contents

Derivatives and Hedging Activities:We recognize all derivatives on the balance sheet at fair value. On the date
we enter into a derivative contract, we designate the derivative as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge or a contract
not qualifying for hedge accounting (free-standing derivative). For a cash flow hedge, we record changes in the fair value of the derivative to the extent that it is effective in other comprehensive income. We subsequently reclassify
these changes in fair value to net income in the same period(s) that the hedge transaction affects net income in the same financial statement category as the hedged item. For freestanding derivatives, we report changes in the fair values in current
period other income. We formally document the relationship between hedging instruments and hedged items. This includes linking all derivatives designated as cash flow hedges to specific forecasted transactions. We also formally assess, both the
inception of the hedge and on an ongoing basis, if the derivatives we use are highly effective in off setting changes in cash flows of hedged items. If we determine that a derivative is not highly effective as a hedge, we discontinue hedge
accounting. We discontinue hedge accounting prospectively when (1) a derivative is no longer highly effective in offsetting changes in cash flows of a hedged item, (2) a derivative expires or is sold, terminated or exercised, (3) a derivative is
designated as a hedge, because it is unlikely that a forecasted transaction will occur, or (4) we determine that designation of a derivative as a hedge is no longer appropriate.



When we discontinue hedge accounting because it is probable that a forecasted transaction will not occur, we continue to carry the
derivative on the balance sheet at its fair value with changes in fair value included in earnings, and immediately recognize gains and losses that were accumulated in other comprehensive income in earnings. When we discontinue hedge accounting
because the hedging instrument is sold, terminated or no longer designated (dedesignated), the amount reported in other comprehensive income up to date of the sale, termination or dedesignation continues to be reported in other comprehensive income
until the forecasted transaction effects earnings. In all other situations in which we discontinue hedge accounting, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current period
earnings.



SFAS No. 123, Accounting for Stock-Based
Compensation, (SFAS 123)requires the disclosure of non-GAAP net income and earnings per share for awards granted or modified after December 31, 1994 as if the Company had accounted for its stock-based awards to employees under
the fair value methods of SFAS 123. The fair value of the Companys stock-based awards to employees was estimated using the Black-Scholes option pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded
options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Companys stock-based
awards to employees have characteristics significantly different from those traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in managements opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its stock-based awards to employees. The Company accounts for stock-based employee compensation using the intrinsic value method under the Financial Standards Board
(FASB) Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB 25), and related interpretations, and complies with the disclosure provisions of Statements of Financial Accounting Standards
No. 123 and 148, (SFAS 123 and SFAS 148, respectively). SFAS 123 requires the disclosure of pro forma net income and earnings per share. Under SFAS 123, the fair value of stock-based awards to employees is calculated through
the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Companys stock option awards.
These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.



The fair value of each option grant and share purchased under the Employee Stock Purchase Plan are estimated on the date of grant or share
purchase using the Black-Scholes option-pricing model with the following estimates used in conjunction with the Black-Scholes option-pricing model:



|                         |  |                            |   |  |                           |   |  |      |   |  |      |  
|------------------------ |  | -------------------------- | - |  | ------------------------- | - |  | ---- | - |  | ---- | -
|                         |  | Three Months EndedJune 30, |   |  | Nine Months EndedJune 30, |  
|                         |  | 2004                       |   |  | 2003                      |   |  | 2004 |   |  | 2003 |  
|                         |  | (in thousands)             |  
|Expected life (in years) |  | 7.0                        |   |  | 7.0                       |   |  | 7.0  |   |  | 7.0  |  
|Expected volatility      |  | 275                        | % |  | 155                       | % |  | 275  | % |  | 155  | %
|Risk-free interest rate  |  | 4.24                       | % |  | 3.03                      | % |  | 4.24 | % |  | 3.03 | %
|Expected dividend yield  |  |                           |   |  |                          |   |  |     |   |  |     |  



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Under the Employee Stock Purchase Plan, rights to purchase shares are only granted during the second and fourth quarter
of each fiscal year. The value of rights to purchase shares granted were estimated at the date of grant using the following weighted average assumptions:



|                         |  |                            |   |  |                           |   |  |      |   |  |      |  
|------------------------ |  | -------------------------- | - |  | ------------------------- | - |  | ---- | - |  | ---- | -
|                         |  | Three Months EndedJune 30, |   |  | Nine Months EndedJune 30, |  
|                         |  | 2004                       |   |  | 2003                      |   |  | 2004 |   |  | 2003 |  
|                         |  | (in thousands)             |  
|Expected life (in years) |  | 2.0                        |   |  | 2.0                       |   |  | 2.0  |   |  | 2.0  |  
|Expected volatility      |  | 254                        | % |  | 155                       | % |  | 254  | % |  | 155  | %
|Risk-free interest rate  |  | 2.70                       | % |  | 1.66                      | % |  | 2.70 | % |  | 1.66 | %
|Expected dividend yield  |  |                           |   |  |                          |   |  |     |   |  |     |  



As required by SFAS No. 148,
Accounting for Stock-Based Compensation, Transition and Disclosure, the following table illustrates the effect on our net loss and net loss per share if we had recorded compensation costs based on the estimated grant date fair value
defined by SFAS No. 123 for all granted stock-based awards (in thousands, except per share amounts):



|                                                                                                                |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                                                |  | Three Months EndedJune 30, |        |   | Nine Months EndedJune 30, |  
|                                                                                                                |  | 2004                       |        |   | 2003                      |   |        | 2004 |  |   | 2003   |  
|                                                                                                                |  | (in thousands)             |       
|Net loss, as reported                                                                                           |  | $                          | (2,276 | ) |                           | $ | (1,379 | )    |  | $ | (2,724 | ) |  | $ | (8,916  | )
|                                                                                                                |  |                            |        |  
|Add: Total stock-based employee compensation expense included in the determination of net loss, as reported     |  |                            |       |   |                           |   |       |      |  |   |       |   |  |   |        |  
|                                                                                                                |  |                            |        |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards |  |                            | 1,578  |   |                           |   | 1,490  |      |  |   | 4,841  |   |  |   | 5,258   |  
|                                                                                                                |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Pro forma net loss                                                                                              |  | $                          | (3,854 | ) |                           | $ | (2,869 | )    |  | $ | (7,565 | ) |  | $ | (14,174 | )
|                                                                                                                |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net loss per share  as reported                                                              |  | $                          | (0.09  | ) |                           | $ | (0.07  | )    |  | $ | (0.12  | ) |  | $ | (0.47   | )
|                                                                                                                |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net loss per share  non-GAAP                                                                 |  | $                          | (0.16  | ) |                           | $ | (0.15  | )    |  | $ | (0.33  | ) |  | $ | (0.74   | )
|                                                                                                                |  |                            |        |   |                           |   |        |      |  |   |        |   |  |   |         |  



The Black-Scholes Single Option
weighted average fair value of employee stock options granted during the three and nine months ended June 30, 2004 was $5.78 and $8.46, respectively. The Black-Scholes Single Option weighted average fair value of employee stock options granted
during the three and nine months ended June 30, 2003 was $3.65 and $3.09, respectively. The weighted average exercise price of employee stock options granted during the nine months ended June 30, 2004 and 2003 was $4.60 and $3.15, respectively.



Estimates: The preparation of financial statements and related
disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.
Estimates are used for, but not limited to, the accounting for doubtful accounts, inventory reserves, depreciation and amortization, asset impairments, sales returns, warranty costs, income taxes, hedging effectiveness determination, and
contingencies. Actual results could differ from these estimates.



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Cash and Cash equivalents: The Company records all investments with a maturity of less than 90 days as cash
equivalents.



Inventories: Inventories are stated at the lower of cost
(first-in, first-out) or market (estimated net realizable value). Inventories, net of reserves were as follows:



|                |  |                |       |                   |   |      
|--------------- |  | -------------- | ----- | ----------------- | - | -----
|                |  | June 30, 2004  |       | September 30,2003
|                |  | (in thousands)
|Raw materials   |  | $              | 2,234 |                   | $ | 1,175
|Work in process |  |                | 126   |                   |   | 213  
|Finished goods  |  |                | 6,586 |                   |   | 4,350
|                |  |                |       |                   |   |      
|                |  | $              | 8,946 |                   | $ | 5,738
|                |  |                |       |                   |   |      



(3) Recent Accounting
Pronouncements



In December 2003, the Financial Accounting Standards Board
(FASB) released a revision to FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. A public entity shall apply the provisions of the FIN 46 revision no later than the end of the first reporting period that ends after March 15, 2004. However, a public entity shall apply
FIN 46 to entities considered to be special-purpose entities no later than as of the end of the first reporting period that ends after December 15, 2003. The Company does not believe the adoption of this standard will have a material impact on our
condensed consolidated financial statements.



In March 2004, the Emerging
Issues Task Force ratified the consensus reached on paragraphs 6 through 23 of Issue No. 03-01 (EITF 03-1), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1 requires that
certain quantitative and qualitative disclosures should be required for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities and SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The Company
does not believe the adoption of this standard will have a material impact on our condensed consolidated financial statements.



In July 2004, the Emerging Issues Task Force (EITF) issued EITF Issue No. 02-14, Whether an Investor Should Apply the Equity Method of Accounting to
Investments Other Than Common Stock. This issue addresses the determination of whether an investment is in-substance common stock and when to perform that evaluation, but does not address the determination of whether an investor has the
ability to exercise significant influence over the operating and financial policies of the investee. The pronouncement is effective for fiscal periods beginning after September 15, 2004. For existing investments, the investor should make an initial
determination as to whether the investment is in-substance common stock based on the circumstances existing as of the date of first application of this issue. The Company does not believe the adoption of this standard will have a material impact on
our condensed consolidated financial statements.



(4) Acquisition



In October 2003, the Company acquired JadeSail Systems, Inc.
(JadeSail), a provider of Internet Protocol (IP) services management and network equipment provisioning software. The Company and JadeSail, consummated the merger (the Merger) whereby Sailaway Merger Sub, Inc., a
California corporation and a wholly-owned subsidiary of Netopia, merged with and into JadeSail pursuant to an Agreement and Plan of Merger and Reorganization dated as of October 3, 2003.



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JadeSail survived the Merger as a wholly owned subsidiary of Netopia. The Company has incorporated the JadeSail
technology into our NBBS software platform in order to increase its functionality.



Under the terms of the merger agreement, the Company issued shares of its common stock in exchange for all the outstanding common stock of JadeSail. The aggregate purchase price was approximately $1.4 million and consisted of (a) 160,000
shares of the Companys common stock, which were valued using the average of the closing price of the Companys common stock for the five day period beginning two days prior to and ending two days after the closing date, and (b) other
transaction related expenses of approximately $0.2 million. The Company accounted for the transaction using the purchase method. The allocation of the purchase price is based upon the Companys estimate of the fair value of the tangible and
intangible assets acquired as follows:



|                              |  |                |       |   |                    |   |             |  |        
|----------------------------- |  | -------------- | ----- | - | ------------------ | - | ----------- |  | -------
|                              |  | Amount         |       |   | AnnualAmortization |   | Useful Life
|                              |  | (in thousands)
|Cash                          |  | $              | 42    |   |                    |   | n/a         |  | n/a    
|Accounts payable              |  |                | (42   | ) |                    |   | n/a         |  | n/a    
|Identified intangible assets: |  |                |       |   |                    |   |             |  |        
|Developed product technology  |  |                | 246   |   |                    | $ | 49          |  | 5 years
|Goodwill                      |  |                | 1,149 |   |                    |   | n/a         |  | n/a    
|                              |  |                |       |   |                    |   |             |  |        
|Total                         |  | $              | 1,395 |   |                    | $ | 49          |  |        
|                              |  |                |       |   |                    |   |             |  |        



The allocation of the total purchase
price of JadeSail to its individual assets and assumed liabilities was based upon the Companys estimate of the fair value thereof. In addition to the current assets and liabilities that were acquired, intangible assets were identified. These
intangible assets were developed product technology, which represents the value of JadeSails proprietary know-how that was technologically feasible as of the acquisition date, and goodwill, which represents the excess of the purchase price
over the fair value of the underlying net identifiable assets. The goodwill was attributed to the Companys Web platforms reporting unit. The value of the developed product technology was determined based upon the value of the cash flows
expected to be generated by the technology as of the acquisition date.



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JadeSails operating results are included in the Companys condensed consolidated financial statements for the
three and the nine months ended June 30, 2004. For comparative purposes the following summary, prepared on an unaudited pro forma basis, reflects the condensed consolidated statements of operations of the Company for the three and the nine months
ended June 30, 2004 giving effect to the JadeSail acquisition and assuming that JadeSail had been acquired as of the beginning of the nine months ended June 30, 2003:



|                                                                          |  |                                          |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                          |  | Three Months EndedJune 30,               |        |   | Nine Months EndedJune 30, |  
|                                                                          |  | 2004                                     |        |   | 2003                      |   |        | 2004 |  |   | 2003   |  
|                                                                          |  | (in thousands; except per share amounts) |       
|Revenue  as reported                                                     |  | $                                        | 25,434 |   |                           | $ | 21,832 |      |  | $ | 75,500 |   |  | $ | 60,004 |  
|Revenue  as pro forma                                                    |  | $                                        | 25,434 |   |                           | $ | 21,858 |      |  | $ | 75,500 |   |  | $ | 60,086 |  
|                                                                          |  |                                          |        |  
|Net income (loss)  as reported                                           |  | $                                        | (2,276 | ) |                           | $ | (1,379 | )    |  | $ | (2,724 | ) |  | $ | (8,916 | )
|Net income (loss)  pro forma                                             |  | $                                        | (2,276 | ) |                           | $ | (1,388 | )    |  | $ | (2,724 | ) |  | $ | (8,631 | )
|                                                                          |  |                                          |        |  
|Basic and Diluted net income (loss) per share  as reported               |  | $                                        | (0.09  | ) |                           | $ | (0.07  | )    |  | $ | (0.12  | ) |  | $ | (0.45  | )
|Basic and Diluted net income (loss) per share  pro forma                 |  | $                                        | (0.09  | ) |                           | $ | (0.07  | )    |  | $ | (0.12  | ) |  | $ | (0.45  | )
|                                                                          |  |                                          |        |  
|Shares used in the basic and diluted per share calculations  as reported |  |                                          | 24,033 |   |                           |   | 19,370 |      |  |   | 23,247 |   |  |   | 19,370 |  
|Shares used in the basic and diluted per share calculations  pro forma   |  |                                          | 24,033 |   |                           |   | 19,530 |      |  |   | 23,247 |   |  |   | 19,530 |  



(5) Goodwill and Other Intangible
Assets



The Companys intangible assets at June 30, 2004 consist
primarily of goodwill acquired in connection with the acquisitions of JadeSail, WebOrder and netOctopus which the Company is not amortizing, and other intangible assets acquired in connection with the JadeSail and Cayman acquisitions, which the
Company is amortizing on a straight-line basis over their estimated useful lives.



The following tables details the Companys goodwill, maintained in its broadband software and services reporting unit, for the three and nine months ended as of June 30, 2004:



|                                 |  |                 |  |                          |       |                                    |   |                           |  |                          |   |  |   |      
|-------------------------------- |  | --------------- |  | ------------------------ | ----- | ---------------------------------- | - | ------------------------- |  | ------------------------ | - |  | - | -----
|                                 |  | Acquisitiondate |  | Balance at March 31,2004 |       | Goodwill acquired duringthe period |   | Goodwillimpairmentcharges |  | Balance at June 30, 2004
|                                 |  | (in thousands) 
|Broadband software and services: |  |                 |  |                          |       |                                    |   |                           |  |                          |   |  |   |      
|JadeSail                         |  | Oct-03          |  | $                        | 1,149 |                                    | $ |                          |  | $                        |  |  | $ | 1,149
|WebOrder                         |  | Mar-00          |  |                          | 519   |                                    |   |                          |  |                          |  |  |   | 519  
|netOctopus                       |  | Dec-98          |  |                          | 465   |                                    |   |                          |  |                          |  |  |   | 465  
|                                 |  |                 |  |                          |       |                                    |   |                           |  |                          |   |  |   |      
|Total                            |  |                 |  | $                        | 2,133 |                                    | $ |                          |  | $                        |  |  | $ | 2,133
|                                 |  |                 |  |                          |       |                                    |   |                           |  |                          |   |  |   |      



|                                 |  |                 |  |                             |     |                                    |   |                           |  |                          |   |  |   |      
|-------------------------------- |  | --------------- |  | --------------------------- | --- | ---------------------------------- | - | ------------------------- |  | ------------------------ | - |  | - | -----
|                                 |  | Acquisitiondate |  | Balance atSeptember 30,2004 |     | Goodwill acquired duringthe period |   | Goodwillimpairmentcharges |  | Balance at June 30, 2004
|                                 |  | (in thousands) 
|Broadband software and services: |  |                 |  |                             |     |                                    |   |                           |  |                          |   |  |   |      
|JadeSail                         |  | Oct-03          |  | $                           |    |                                    | $ | 1,149                     |  | $                        |  |  | $ | 1,149
|WebOrder                         |  | Mar-00          |  |                             | 519 |                                    |   |                          |  |                          |  |  |   | 519  
|netOctopus                       |  | Dec-98          |  |                             | 465 |                                    |   |                          |  |                          |  |  |   | 465  
|                                 |  |                 |  |                             |     |                                    |   |                           |  |                          |   |  |   |      
|Total                            |  |                 |  | $                           | 984 |                                    | $ | 1,149                     |  | $                        |  |  | $ | 2,133
|                                 |  |                 |  |                             |     |                                    |   |                           |  |                          |   |  |   |      



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The following tables detail the Companys other intangible assets, by reporting unit, for the three and nine months
ended as of June 30, 2004:



|                                 |  |                                |  |                           |       |                                                  |   |                     |  |                          |     |  |   |      
|-------------------------------- |  | ------------------------------ |  | ------------------------- | ----- | ------------------------------------------------ | - | ------------------- |  | ------------------------ | --- |  | - | -----
|                                 |  | Acquisitionandacquisition date |  | Balance at March 31, 2004 |       | Other intangible assetsacquired duringthe period |   | Amortizationexpense |  | Balance at June 30, 2004
|                                 |  | (in thousands)                
|Broadband equipment:             |  |                                |  |                           |       |                                                  |   |                     |  |                          |     |  |   |      
|Acquired technology              |  | CaymanOct-01                   |  | $                         | 3,809 |                                                  | $ |                    |  | $                        | 289 |  | $ | 3,520
|Sales channel relationships      |  | CaymanOct-01                   |  |                           | 518   |                                                  |   |                    |  |                          | 86  |  |   | 432  
|                                 |  |                                |  |                           |       |                                                  |   |                     |  |                          |     |  |   |      
|Subtotal                         |  |                                |  |                           | 4,327 |                                                  |   |                    |  |                          | 375 |  |   | 3,952
|                                 |  |                                |  |                           |      
|Broadband software and services: |  |                                |  |                           |       |                                                  |   |                     |  |                          |     |  |   |      
|Acquired technology              |  | JadeSailOct-03                 |  |                           | 221   |                                                  |   |                    |  |                          | 12  |  |   | 209  
|Marketing license                |  | Jan-03                         |  |                           | 291   |                                                  |   |                    |  |                          | 24  |  |   | 267  
|                                 |  |                                |  |                           |       |                                                  |   |                     |  |                          |     |  |   |      
|Subtotal                         |  |                                |  |                           | 512   |                                                  |   |                    |  |                          | 36  |  |   | 475  
|                                 |  |                                |  |                           |       |                                                  |   |                     |  |                          |     |  |   |      
|Total                            |  |                                |  | $                         | 4,839 |                                                  | $ |                    |  | $                        | 411 |  | $ | 4,428
|                                 |  |                                |  |                           |       |                                                  |   |                     |  |                          |     |  |   |      



|                                 |  |                                |  |                             |       |                                                  |   |                     |  |                          |       |  |   |      
|-------------------------------- |  | ------------------------------ |  | --------------------------- | ----- | ------------------------------------------------ | - | ------------------- |  | ------------------------ | ----- |  | - | -----
|                                 |  | Acquisitionandacquisition date |  | Balance atSeptember 30,2003 |       | Other intangible assetsacquired duringthe period |   | AmortizationExpense |  | Balance at June 30, 2004
|                                 |  | (in thousands)                
|Broadband equipment:             |  |                                |  |                             |       |                                                  |   |                     |  |                          |       |  |   |      
|Acquired technology              |  | CaymanOct-01                   |  | $                           | 4,386 |                                                  | $ |                    |  | $                        | 866   |  | $ | 3,520
|Sales channel relationships      |  | CaymanOct-01                   |  |                             | 690   |                                                  |   |                    |  |                          | 258   |  |   | 432  
|                                 |  |                                |  |                             |       |                                                  |   |                     |  |                          |       |  |   |      
|Subtotal                         |  |                                |  |                             | 5,076 |                                                  |   |                    |  |                          | 1,124 |  |   | 3,952
|Broadband software and services: |  |                                |  |                             |       |                                                  |   |                     |  |                          |       |  |   |      
|Acquired technology              |  | JadeSailOct-03                 |  |                             |      |                                                  |   | 246                 |  |                          | 37    |  |   | 209  
|Marketing license                |  | Jan-03                         |  |                             | 175   |                                                  |   | 300                 |  |                          | 208   |  |   | 267  
|                                 |  |                                |  |                             |       |                                                  |   |                     |  |                          |       |  |   |      
|Subtotal                         |  |                                |  |                             | 175   |                                                  |   | 546                 |  |                          | 245   |  |   | 475  
|                                 |  |                                |  |                             |       |                                                  |   |                     |  |                          |       |  |   |      
|Total                            |  |                                |  | $                           | 5,251 |                                                  | $ | 546                 |  | $                        | 1,369 |  | $ | 4,428
|                                 |  |                                |  |                             |       |                                                  |   |                     |  |                          |       |  |   |      



(6) Per Share Calculations



Basic net income (loss) per share is based on the weighted average number
of shares of common stock outstanding during the period. Diluted net income (loss) per share is based on the weighted average number of shares of common stock outstanding during the period plus potential dilutive shares from options outstanding
using the treasury stock method. All potential dilutive shares have been excluded from the computation of the diluted loss per share for the three and nine months



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ended June 30, 2004 and 2003, as their effect on the loss per share was anti-dilutive. The following chart details the Companys per share calculations
for the periods indicated:



|                                                  |  |                          |        |   |                          |   |        |                         |  |   |                         |   |  |   |        |  
|------------------------------------------------- |  | ------------------------ | ------ | - | ------------------------ | - | ------ | ----------------------- |  | - | ----------------------- | - |  | - | ------ | -
|                                                  |  | ThreeMonthsEndedJune 30, |        |   | ThreeMonthsEndedJune 30, |   |        | NineMonthsEndedJune 30, |  |   | NineMonthsEndedJune 30, |  
|(in thousands; except per share amounts)          |  | 2004                     |        |   | 2003                     |   |        | 2004                    |  |   | 2003                    |  
|Calculation of basic net income (loss) per share: |  |                          |        |   |                          |   |        |                         |  |   |                         |   |  |   |        |  
|Net income (loss)                                 |  | $                        | (2,276 | ) |                          | $ | (1,379 | )                       |  | $ | (2,724                  | ) |  | $ | (8,916 | )
|Weighted average basic shares outstanding         |  |                          | 24,033 |   |                          |   | 19,370 |                         |  |   | 23,247                  |   |  |   | 19,059 |  
|                                                  |  |                          |        |   |                          |   |        |                         |  |   |                         |   |  |   |        |  
|Basic net income (loss) per share                 |  | $                        | (0.09  | ) |                          | $ | (0.07  | )                       |  | $ | (0.12                   | ) |  | $ | (0.47  | )
|                                                  |  |                          |        |   |                          |   |        |                         |  |   |                         |   |  |   |        |  



For the nine months ended June 30,
2004, potential dilutive common shares excluded from the computation of diluted loss per share consisted of options to purchase common stock totaling 3,613,129 shares, with a weighted average exercise price of $4.60. For the nine months ended June
30, 2003, potential dilutive common shares excluded from the computation of diluted loss per share consisted of options to purchase common stock totaling 7,807,238 shares, with a weighted average exercise price of $4.22.



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(7) Segment, Geographic and Significant Customer Information



Segment Information: The Company applies the provisions of SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information, which establishes standards for the reporting by public business enterprises of information about operating segments, products and services, geographic areas,
and major customers. The Company operates in two segments, broadband equipment and broadband software and services. The Company evaluates performance based on net revenues and gross profits from operations of these two segments, which is detailed
for the three and nine months ended June 30, 2004 and 2003 as follows:



|                                    |  |                    |        |   |                             |   |        |       |  |   |                    |   |  |                              |        |   |       |   |        |   |  |   |        |  
|----------------------------------- |  | ------------------ | ------ | - | --------------------------- | - | ------ | ----- |  | - | ------------------ | - |  | ---------------------------- | ------ | - | ----- | - | ------ | - |  | - | ------ | -
|                                    |  | 2004               |        |   | 2003                        |  
|Three months ended June 30,         |  | Broadbandequipment |        |   | BroadbandSoftware &Services |   |        | Total |  |   | Broadbandequipment |   |  | BroadbandSoftware &Services  |        |   | Total |  
|                                    |  | ($ in thousands)   |       
|Revenue                             |  | $                  | 21,891 |   |                             | $ | 3,543  |       |  | $ | 25,434             |   |  | $                            | 17,718 |   |       | $ | 4,114  |   |  | $ | 21,832 |  
|Cost of revenues                    |  |                    | 16,757 |   |                             |   | 267    |       |  |   | 17,024             |   |  |                              | 12,808 |   |       |   | 316    |   |  |   | 13,124 |  
|Amortization of acquired technology |  |                    | 288    |   |                             |   | 12     |       |  |   | 300                |   |  |                              | 288    |   |       |   |       |   |  |   | 288    |  
|                                    |  |                    |        |   |                             |   |        |       |  |   |                    |   |  |                              |        |   |       |   |        |   |  |   |        |  
|Gross profit                        |  |                    | 4,846  |   |                             |   | 3,264  |       |  |   | 8,110              |   |  |                              | 4,622  |   |       |   | 3,798  |   |  |   | 8,420  |  
|Gross margin                        |  |                    | 22     | % |                             |   | 92     | %     |  |   | 32                 | % |  |                              | 26     | % |       |   | 92     | % |  |   | 39     | %
|Unallocated operating expenses      |  |                    |       |   |                             |   |       |       |  |   | 10,315             |   |  |                              |       |   |       |   |       |   |  |   | 9,796  |  
|                                    |  |                    |        |   |                             |   |        |       |  |   |                    |   |  |                              |        |   |       |   |        |   |  |   |        |  
|Operating loss                      |  | $                  |       |   |                             | $ |       |       |  | $ | (2,205             | ) |  | $                            |       |   |       | $ |       |   |  | $ | (1,376 | )
|                                    |  |                    |        |   |                             |   |        |       |  |   |                    |   |  |                              |        |   |       |   |        |   |  |   |        |  
|                                    |  |                   
|                                    |  | 2004               |        |   | 2003                        |  
|Nine months ended June 30,          |  | Broadbandequipment |        |   | BroadbandSoftware &Services |   |        | Total |  |   | Broadbandequipment |   |  | BroadbandSoftware & Services |        |   | Total |  
|                                    |  | ($ in thousands)   |       
|Revenue                             |  | $                  | 63,426 |   |                             | $ | 12,074 |       |  | $ | 75,500             |   |  | $                            | 46,771 |   |       | $ | 13,233 |   |  | $ | 60,004 |  
|Cost of revenues                    |  |                    | 45,780 |   |                             |   | 706    |       |  |   | 46,486             |   |  |                              | 34,671 |   |       |   | 1,090  |   |  |   | 35,761 |  
|Amortization of acquired technology |  |                    | 864    |   |                             |   | 36     |       |  |   | 900                |   |  |                              | 864    |   |       |   |       |   |  |   | 864    |  
|                                    |  |                    |        |   |                             |   |        |       |  |   |                    |   |  |                              |        |   |       |   |        |   |  |   |        |  
|Gross profit                        |  |                    | 16,782 |   |                             |   | 11,332 |       |  |   | 28,114             |   |  |                              | 11,236 |   |       |   | 12,143 |   |  |   | 23,379 |  
|Gross margin                        |  |                    | 26     | % |                             |   | 94     | %     |  |   | 37                 | % |  |                              | 27     | % |       |   | 92     | % |  |   | 42     | %
|Unallocated operating expenses      |  |                    |       |   |                             |   |       |       |  |   | 30,966             |   |  |                              |       |   |       |   |       |   |  |   | 31,823 |  
|                                    |  |                    |        |   |                             |   |        |       |  |   |                    |   |  |                              |        |   |       |   |        |   |  |   |        |  
|Operating loss                      |  | $                  |       |   |                             | $ |       |       |  | $ | (2,852             | ) |  | $                            |       |   |       | $ |       |   |  | $ | (8,444 | )
|                                    |  |                    |        |   |                             |   |        |       |  |   |                    |   |  |                              |        |   |       |   |        |   |  |   |        |  



Geographic Information:
The Company sells its products and provides services worldwide through a direct sales force, independent non-exclusive distributors and value-added resellers. The Company operates primarily in four regions: United States, Europe, Canada, and Asia
Pacific. Revenues outside of the United States are primarily export sales denominated in United States dollars or Euros. Disaggregated financial information regarding the Companys revenues by geographic region for the three and nine months
ended June 30, 2004 and 2003 is as follows:



|                               |  |                             |        |  |                            |   |      |   |        |      |     |   |      |   |        |  |     |   |  |   |        |  |     |  
|------------------------------ |  | --------------------------- | ------ |  | -------------------------- | - | ---- | - | ------ | ---- | --- | - | ---- | - | ------ |  | --- | - |  | - | ------ |  | --- | -
|                               |  | Three months ended June 30, |        |  | Nine months ended June 30, |  
|                               |  | 2004                        |        |  |                            |   | 2003 |   |        | 2004 |     |   | 2003 |  
|                               |  | ($ in thousands)            |       
|Europe                         |  | $                           | 9,427  |  | 37                         | % |      | $ | 6,904  |      | 32  | % |      | $ | 29,422 |  | 39  | % |  | $ | 16,511 |  | 28  | %
|Canada                         |  |                             | 235    |  | 1                          | % |      |   | 174    |      | 1   | % |      |   | 594    |  | 1   | % |  |   | 673    |  | 1   | %
|Asia Pacific and other         |  |                             | 462    |  | 2                          | % |      |   | 221    |      | 1   | % |      |   | 171    |  | 0   | % |  |   | 1,290  |  | 2   | %
|                               |  |                             |        |  |                            |   |      |   |        |      |     |   |      |   |        |  |     |   |  |   |        |  |     |  
|Subtotal international revenue |  |                             | 10,124 |  | 40                         | % |      |   | 7,299  |      | 33  | % |      |   | 30,187 |  | 40  | % |  |   | 18,474 |  | 31  | %
|United States                  |  |                             | 15,310 |  | 60                         | % |      |   | 14,533 |      | 67  | % |      |   | 45,313 |  | 60  | % |  |   | 41,530 |  | 69  | %
|                               |  |                             |        |  |                            |   |      |   |        |      |     |   |      |   |        |  |     |   |  |   |        |  |     |  
|Total revenues                 |  | $                           | 25,434 |  | 100                        | % |      | $ | 21,832 |      | 100 | % |      | $ | 75,500 |  | 100 | % |  | $ | 60,004 |  | 100 | %
|                               |  |                             |        |  |                            |   |      |   |        |      |     |   |      |   |        |  |     |   |  |   |        |  |     |  



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The Company has no material operating assets outside the United States.



Customer Information: The Company sells its products to incumbent local
exchange carriers (ILECs), competitive local exchange carriers (CLECs), distributors, Internet service providers (ISPs) and directly to end-users. Disaggregated financial information regarding the Companys
customers that accounted for 10% or more of the Companys revenue for the three and nine months ended June 30, 2004 and 2003 is as follows:



|                                     |  |                             |       |  |                            |   |      |   |       |  |     |      |  |   |        |  |      |   |  |   |       |  |     |  
|------------------------------------ |  | --------------------------- | ----- |  | -------------------------- | - | ---- | - | ----- |  | --- | ---- |  | - | ------ |  | ---- | - |  | - | ----- |  | --- | -
|                                     |  | Three months ended June 30, |       |  | Nine months ended June 30, |  
|                                     |  | 2004                        |       |  |                            |   | 2003 |   |       |  |     | 2004 |  |   |        |  | 2003 |   |  |  
|                                     |  | ($ in thousands)            |      
|Swisscom AG (Swisscom)               |  | $                           | 3,744 |  | 15                         | % |      | $ | 4,096 |  | 19  | %    |  | $ | 15,436 |  | 20   | % |  | $ | 7,506 |  | 13  | %
|SBC Communications, Inc. (SBC)       |  |                             | 2,781 |  | 11                         | % |      |   | 2,870 |  | 13  | %    |  |   | 7,748  |  | 10   | % |  |   | 7,372 |  | 12  | %
|Covad Communications Company (Covad) |  |                             | n/a   |  | n/a                        |   |      |   | 3,279 |  | 15  | %    |  |   | 5,879  |  | 8    | % |  |   | 8,915 |  | 15  | %
|Belgacom                             |  |                             | 2,611 |  | 10                         | % |      |   |      |  |    |      |  |   | 3,237  |  | 4    | % |  |   |      |  |    |  
|BellSouth                            |  |                             | 2,905 |  | 11                         | % |      |   | n/a   |  | n/a |      |  |   | 5,156  |  | 7    | % |  |   | n/a   |  | n/a |  



For the three months ended June 30,
2004 and 2003, there were four and three customers, respectively, that each individually represented at least 10% of the Companys revenues and in the aggregate, accounted for 47% and 47%, respectively, of the Companys total revenues. For
the nine months ended June 30, 2004 and 2003, there were five and four customers, respectively, that each represented at least 10% of the Companys revenues and in the aggregate, accounted for 49% and 41%, respectively, of the Companys
total revenues. No other customers during the three or nine months ended June 30, 2004 and 2003 accounted for 10% or more of the Companys total revenues.



The following table sets forth the accounts receivable balance for the customers identified above along with such data expressed as a percentage of total accounts
receivable:



|          |  |                  |       |  |    |   |      |   |       |  |     |  
|--------- |  | ---------------- | ----- |  | -- | - | ---- | - | ----- |  | --- | -
|June 30,  |  | 2004             |       |  |    |   | 2003 |   |       | 
|          |  | ($ in thousands) |       |  |   
|Swisscom  |  | $                | 3,718 |  | 23 | % |      | $ | 3,076 |  | 20  | %
|BellSouth |  |                  | 1,920 |  | 12 | % |      |   | n/a   |  | n/a |  
|SBC       |  |                  | 1,586 |  | 10 | % |      |   | 187   |  | 1   | %
|Covad     |  |                  | 936   |  | 6  | % |      |   | 2,135 |  | 14  | %



(8) Investment in Non-Public
Entities



At June 30, 2004 the Company owned 1,850,000 shares of MegaPath,
which represents approximately a 1.8% interest. MegaPath offers high-speed broadband access to small and medium size businesses. Although there is no public market for MegaPaths stock, the Company believes that the market value of its
long-term investment in MegaPath is not less than the Companys $1.0 million carrying value at June 30, 2004 because MegaPaths most recent financing used a significantly higher valuation.



During the three and nine months ended June 30, 2004 MegaPath purchased $0.5 and $1.1
million, respectively, of the Companys products. During the three and nine months ended June 30, 2003 MegaPath purchased $0.3 million and $1.1 million, respectively, of the Companys products. At June 30, 2004, MegaPaths accounts
receivable with the Company was $0.2 million.



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(9) Restructuring Costs



During the three months ended June 30, 2003, the Company recorded a restructuring charge of $0.3 million, primarily consisting of employee severance benefits. The
Companys policy is to maintain accruals relating to restructurings for up to two years unless the Company has had definitive closure of the specific liabilities accrued prior to the two-year final review date. Detail of the Companys
remaining liabilities relating to its restructuring activities is as follows:



|                              |  |                           |    |       |   |       |  |   |   
|----------------------------- |  | ------------------------- | -- | ----- | - | ----- |  | - | --
|                              |  | Employeeseverancebenefits |    | Other |   | Total
|                              |  | (in thousands)           
|Balance at September 30, 2003 |  | $                         | 15 |       | $ |      |  | $ | 15
|Less: Amounts paid            |  |                           |   |       |   |      |  |   |  
|                              |  |                           |    |       |   |       |  |   |   
|Balance at June 30, 2004      |  | $                         | 15 |       | $ |      |  | $ | 15
|                              |  |                           |    |       |   |       |  |   |   



(10) Credit Facility



On June 28, 2004, the Company amended its credit facility agreement with
Silicon Valley Bank, which resulted in an extension and amendments to the tangible net worth covenant. The new covenant requires that the Company must maintain a minimum tangible net worth of $34 million plus 50% of the Companys net income in
each fiscal quarter commencing with the first fiscal quarter ending September 30, 2004 and shall continue effective thereafter, as well as amending Collection of Accounts, Filing of the Transaction Reports, Limits on the Revolving Loans, Collateral
Monitoring Fee and Interest Rate on the Loans as noted below. The Company must also maintain an adjusted quick ratio, as defined as the ratio of (i) the Companys unrestricted cash maintained at Silicon Valley Bank plus cash equivalents
maintained at Silicon Valley Bank plus receivables and investments made on behalf of the Company through Silicon Valley Banks Investment Product Services Division (ISP Division) to (ii) the Companys current liabilities plus the
outstanding principal amount of any obligations less deferred revenues, of not less than 1.25 to 1 from April 30, 2003, and each month ending thereafter.



The Credit Facility bears interest at a rate equal to the prime rate (the rate announced by Silicon Valley Bank as its prime rate) plus 1.00% per annum. As
provided in the June 28, 2004 amendment, as long as no Default or Event of Default has occurred and is continuing, and as long as the Company maintains profitability as of the end of each fiscal quarter within the
two-consecutive-fiscal-quarter-period most recently ended, the Credit Facility will bear interest equal to Silicon Valley Banks prime rate only. At June 30, 2004, the prime rate for Silicon Valley Bank was 4.0%. The
Company may borrow under the Credit Facility in order to finance working capital requirements for new products and customers, and otherwise for general corporate purposes in the normal course of business.



As of June 30, 2004, the Company had no outstanding borrowings under the Credit Facility and
had a borrowing availability of approximately $11.9 million.



On February 25,
2003, Silicon Valley Bank made a term loan to the Company in the original principal amount of $0.2 million. The principal amount of Term Loan A is payable in twenty-four equal monthly payments of principal in the amount of $8,333.33 per month,
commencing on March 1, 2003 and continuing until paid in full. The remaining balance of $66,667 of Term Loan A, which is expected to be repaid within 12-months, is recorded as a current liability on the Companys June 30, 2004 condensed
consolidated balance sheet. Term Loan A bears interest at a rate equal to Silicon Valley Banks prime rate plus 0.75% per annum. As provided in the November 26, 2003 amendment, as long as no Default or Event of Default has occurred and is
continuing, and as long as the Company maintains profitability as of the end of each fiscal quarter, Term Loan A will bear interest equal to Silicon Valley Banks prime rate only. At June 30, 2004, the Silicon Valley Banks
prime rate for Term Loan A was 4.0%. Upon the repayment of any portion of Term Loan A, such portion may not be re-borrowed. The outstanding principal balance of Term Loan A shall be reserved from the amount of credit facility otherwise
available to the Company.



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Term Loan B. On February 25, 2003, Silicon Valley Bank made a term loan to the Company in the original principal
amount of $0.3 million. The principal amount of Term Loan B is payable in twenty-four equal monthly payments of principal in the amount of $12,500.00 per month, commencing on March 1, 2003 and continuing until paid in full. The remaining balance of
$100,000 of Term Loan B, which is expected to be repaid within 12-months, is recorded as a current liability on the Companys June 30, 2004 condensed consolidated balance sheet Term Loan B bears interest at a rate equal to Silicon Valley Banks
prime rate plus 1.00% per annum. As provided in the November 26, 2003 amendment, as long as no Default or Event of Default has occurred and is continuing, and as long as the Company maintains profitability as of the end of each fiscal quarter, Term
Loan B will bear interest at a rate equal to Silicon Valley Banks prime rate only. At June 30, 2004, the Silicon Valley Banks prime rate for Term Loan B was 4.0%. Upon the repayment of any portion of Term Loan B,
such portion may not be re-borrowed.



(11) Other Income (Loss), Net



Other income (loss), net consists of interest income the Company earns on
its cash and cash equivalents, interest expense related to the Companys borrowing under its credit facility and term loans and gains and losses on foreign currency transactions. The following table sets forth for the periods indicated detail
of the Companys other income (loss), net:



|                            |  |                           |     |   |                          |   |     |      |  |   |      |   |  |   |      |  
|--------------------------- |  | ------------------------- | --- | - | ------------------------ | - | --- | ---- |  | - | ---- | - |  | - | ---- | -
|                            |  | For the Three MonthsEnded |     |   | For the Nine MonthsEnded |  
|June 30,                    |  | 2004                      |     |   | 2003                     |   |     | 2004 |  |   | 2003 |  
|                            |  | (in thousands)            |    
|Loss on impaired securities |  | $                         |    |   |                          | $ |    |      |  | $ |     |   |  | $ | (457 | )
|Interest income             |  |                           | 42  |   |                          |   | 33  |      |  |   | 134  |   |  |   | 145  |  
|Interest expense            |  |                           | (29 | ) |                          |   | (94 | )    |  |   | (17  | ) |  |   | (237 | )
|Other (Income)              |  |                           | (65 | ) |                          |   | 58  |      |  |   | 76   |   |  |   | 77   |  
|                            |  |                           |     |   |                          |   |     |      |  |   |      |   |  |   |      |  
|Total                       |  | $                         | (52 | ) |                          | $ | (3  | )    |  | $ | 193  |   |  | $ | (472 | )
|                            |  |                           |     |   |                          |   |     |      |  |   |      |   |  |   |      |  



(12) Financial Instruments



The Company generates revenues and cash receipts in non-U.S. dollars in
addition to incurring a portion of its operating expenses in foreign currency, primarily the Euro. The Company uses forward currency contracts and hedges forecasted transactions in accordance with SFAS 133, Accounting for Derivative Instruments
and Hedging Activities, as amended. The Company recognizes derivative instruments and hedging activities as either assets or liabilities on the balance sheet and measures them at fair value. Gains and losses resulting from changes in fair value
are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting.



Hedges of Forecasted Transactions



The Company uses forward foreign exchange contracts to hedge certain operational (cash flow) exposures resulting from changes in foreign currency exchange
rates. These foreign exchange contracts, carried at fair value, have maturities between one and two months. Such cash flow exposures result from portions of the Companys forecasted revenues denominated in the Euro. The Company enters into
these foreign exchange contracts to hedge forecasted broadband equipment revenues in the normal course of business, and accordingly, they are not speculative in nature.



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The critical terms of the cash flow hedging instruments are the same as the underlying forecasted transactions. The
changes in fair value of the derivatives are intended to offset changes in the expected cash flows from the forecasted transactions. The Company records the ineffective portion of the hedging instruments in other income (loss) on the consolidated
statement of operations. As of June 30, 2004, no hedge ineffectiveness occurred. The Company has not excluded any component of the derivative instrument when assessing the hedge effectiveness.



The Company records changes in the fair value of these cash flow hedges in accumulated other
comprehensive loss, until the forecasted transaction occurs. When the forecasted transaction occurs, the Company reclassifies the related gain or loss on the cash flow hedge to broadband equipment revenue. In the event the underlying forecasted
transaction does not occur, or it becomes probable that it will not occur, the Company reclassifies the gain or loss on the related cash flow hedge from accumulated other comprehensive income (loss) to other income (loss), net on the consolidated
statement of operations at that time. For the quarter ended June 30, 2004, there were no such gains or losses recognized in other income (loss), net relating to hedges of forecasted transactions that did not occur.



|                                                                                        |  |                            |     |                           |      |   |      |  |   |      |   |  |   |  
|--------------------------------------------------------------------------------------- |  | -------------------------- | --- | ------------------------- | ---- | - | ---- |  | - | ---- | - |  | - | -
|                                                                                        |  | Three Months EndedJune 30, |     | Nine Months EndedJune 30,
|                                                                                        |  | 2004                       |     |                           | 2003 |   | 2004 |  |   | 2003
|                                                                                        |  | (in thousands)            
|Balance Sheet                                                                           |  |                            |     |                           |      |   |      |  |   |      |   |  |   |  
|Unrealized net loss remaining in other comprehensive loss                               |  | $                          | (62 | )                         |      | $ |     |  | $ | (62  | ) |  | $ | 
|Income Statement                                                                        |  |                            |     |                           |      |   |      |  |   |      |   |  |   |  
|Realized net loss reclassified from other comprehensive loss  (Net revenue)            |  | $                          |    |                           |      | $ |     |  | $ |     |   |  | $ | 
|Realized net loss from any ineffective portion of hedges  (Other income (loss), net)   |  | $                          |    |                           |      | $ |     |  | $ |     |   |  | $ | 
|                                                                                        |  |                            |     |                          
|Unrealized net loss from any ineffective portion of hedges - (Other income (loss), net) |  | $                          |    |                           |      | $ |     |  | $ |     |   |  | $ | 



Hedging of Foreign Currency Assets
and Liabilities



The Company hedges its foreign currency assets and
liabilities, primarily trade accounts receivable and trade accounts payable, with foreign exchange forwards. These derivative instruments hedge assets and liabilities that are denominated in foreign currencies and are carried at fair value with
changes in the fair value recorded as other income (loss). These derivative instruments do not subject the Company to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are largely offset by
gains and losses resulting from remeasurement of the foreign currency denominated assets and liabilities (in accordance with SFAS 52 Foreign Currency Translation) being hedged. At June 30, 2004, the outstanding balance sheet hedging
derivatives had maturities of 150 days or less.



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Net losses recognized in other income (loss) relating to balance sheet hedging for the three and nine months ended June
30, 2004 and 2003 were as follows:



|                                                                                    |  |                                     |     |   |                                               |   |    |                                              |  |                             |    |  |   |    |  
|----------------------------------------------------------------------------------- |  | ----------------------------------- | --- | - | --------------------------------------------- | - | -- | -------------------------------------------- |  | --------------------------- | -- |  | - | -- | -
|                                                                                    |  | Three Months Ended June 30,         |     |   | Nine Months Ended June 30,                    |  
|                                                                                    |  | 2004                                |     |   | 2003                                          |   |    | 2004                                         |  | 2003                        |   
|                                                                                    |  | (in thousands)                      |    
|Net gain (loss) recognized in other income (loss)                                   |  | $                                   | (65 | ) |                                               | $ | 58 |                                              |  | $                           | 76 |  | $ | 77 |  
|                                                                                    |  |                                     |     |   |                                               |   |    |                                              |  |                             |    |  |   |    |  
|                                                                                    |  |                                     |     |  
|Other Comprehensive (loss)                                                          |  | Beginning Balance September30, 2003 |     |   | NetChange ofcurrent period hedging activities |   |    | Reclassification into earningscurrent period |  | Ending Balance June 30,2004 |   
|                                                                                    |  | (in thousands)                      |    
|Unrealized net gain (loss) of hedging instruments recognized in other income (loss) |  | $                                   |    |   |                                               | $ | (9 | )                                            |  | $                           |   |  | $ | (9 | )



The Company expects to reclassify
$8,000 from other comprehensive (loss) into the Consolidated Statement of Operations within the next twelve months.



|(13) | Subsequent Events
|---- | -----------------



In August 2004, the first of four purported class action complaints, Valentin Serafimov, on behalf of himself and all others similarly situated, v. Netopia, Inc., Alan
B. Lefkof and William D. Baker, was filed in the United States District Court for the Northern District of California. The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The
complaint alleged that during the purported class period, November 6, 2003 and July 6, 2004, we made materially false, misleading and incomplete statements and issued false and misleading reports regarding our earnings, product costs, and sales to
foreign customers. The other three complaints that subsequently were filed made additional related claims based on the same announcements and allegations of misstatements. As provided in the Private Securities Litigation Reform Act of 1995, the
plaintiffs in these actions filed motions to consolidate and to appoint lead plaintiff and lead plaintiff counsel. On December 3, 2004, the court issued an order consolidating the cases under the name In re Netopia, Inc. Securities
Litigation, and appointing a lead plaintiff and plaintiffs counsel. The lead plaintiff has not filed its consolidated amended complaint. We believe that we have strong defenses to the claims asserted in the complaints as initially filed.
We intend to defend the case vigorously.



In August 2004, the first of four
purported derivative actions, Freeport Partners, LLC, Derivatively on Behalf of Nominal Defendant Netopia, Inc., v. Alan B. Lefkof, William D. Baker, Reese M. Jones, Harold S. Wills, Robert Lee and Netopia, Inc., was filed in the
United States District Court for the Northern District of California. Two purported derivative actions are pending in the United States District Court for the Northern District of California, and two related purported derivative actions are pending
in the Superior Court of California for the County of Alameda. These actions make claims against our officers and directors arising out of the same announcements and alleged misstatements described above in connection with the purported class
actions. In November 2004, the derivative plaintiffs agreed to coordinate the four derivative actions. The parties have agreed to a stay of the federal derivative actions, which was ordered by the court in January 2005. The state actions have been
consolidated under the name In re Netopia, Inc.Derivative Litigation. The plaintiffs have not filed their consolidated amended complaint. We believe that we have strong defenses to the claims asserted in the complaints as initially
filed. We intend to defend the cases vigorously.



On October 29, 2004, we were
advised by the Securities and Exchange Commission that an informal inquiry previously commenced by the Securities and Exchange Commission had become the subject of a formal order of investigation. This investigation is to determine whether the
federal securities laws have been violated. We cooperated fully with the informal inquiry, and we are cooperating fully with the formal investigation. Responding to the formal investigation will likely continue to require significant attention and
resources of management. If the Securities and Exchange Commission elects to pursue an enforcement action, the defense against this type of action could be costly and require additional



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##### Table of Contents

management resources. If we were unsuccessful in defending against this or other investigations or proceedings, we could face civil or criminal penalties
that would seriously harm our business and results of operations.



Defending
against the securities class action and derivative actions will likely require significant attention and resources of management and, regardless of the outcome, result in significant legal expense. If our defenses ultimately are unsuccessful, or if
we are unable to achieve a favorable settlement, we could be liable for large damage awards that could seriously harm our business and results of operation. While we have provided notice of the securities class action and derivative actions to our
directors and officers liability insurance carriers, the insurance carriers have not agreed to pay for our legal expenses incurred in defending against these actions or agreed that they are responsible to pay any damages that ultimately could be
awarded to the plaintiffs. Furthermore, we have only a limited amount of insurance, and even if our insurers agree to make payments under the policies, the damage awards or settlements may be greater than the amount of insurance, and we would in all
cases be liable for any amounts in excess of our insurance policy limits.



On
August 24, 2004, the Company received a NASDAQ Staff Determination indicating that the Company had failed to timely file its quarterly report on Form 10-Q for the period ended June 30, 2004, as required by Nasdaq Marketplace Rule 4310(c)(14), and
that the Companys common stock is therefore subject to delisting from The Nasdaq National Market. As a result of the Companys filing delinquency, the Companys common stock was delisted from The Nasdaq National Market effective with
the open of business on October 20, 2004. Commencing October 20, 2004, quotations for the Companys common stock appear in the National Daily Quotations Journal, often referred to as the pink sheets, where subscribing dealers can
submit bid and ask prices on a daily basis. The Companys trading symbol on the pink sheets is NTPA.PK.



On October 21, 2004, the Company announced the resignation of William D. Baker as the Companys Senior Vice President, Finance and Operations, and Chief Financial
Officer and the appointment of Mark H. Perry as the Companys Interim Senior Vice President and Chief Financial Officer.



We have devoted substantial resources and managements time in connection with the Internal Accounting Review described below, which has resulted in the restatement
of our financial statements for the fiscal years ended September 30, 2002 and 2003, and our interim financial statements for fiscal quarters ended December 31, 2003 and March 31, 2004. As a result of the Internal Accounting Review commenced in July
2004, the filing of both this Report on Form 10-Q for the third fiscal quarter ended June 30, 2004 and the 2004 10-K have been delayed beyond the designated filing deadlines.



The Company has restated its consolidated statements for the fiscal years ended September 30, 2002 and 2003 and for all quarters from
December 31, 2001 through March 31, 2004, inclusive. All applicable financial information in the consolidated financial statements in the 2004 10-K gives effect to the restatements. Accordingly, the financial statements for those fiscal periods that
have been included in the Companys previous filings with the Securities and Exchange Commission or included in previous announcements should not be relied upon.



Internal Accounting Review



We announced on July 22, 2004, that the Audit Committee of our Board of Directors had initiated an Internal Accounting Review of our accounting and reporting practices,
including the appropriateness and timing of the revenue recognition of software license and maintenance fees in two transactions with a single software reseller customer. On September 10, 2004, KPMG LLP, which had served as our independent
registered accountant, resigned. At the time of its resignation, KPMG LLP advised us that our audited financial statements for fiscal year ended September 30, 2003 should no longer be relied upon. On September 30, 2004, the Audit Committee engaged
Burr, Pilger & Mayer LLP (BPM) as our new independent registered public accounting firm to audit our consolidated financial statements for the fiscal years ended September 30, 2004, 2003 and 2002.



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The Internal Accounting Review determined that both software transactions referred to above were contingent sales. As a
consequence, and, in accordance with the principles of Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended, we are restating revenue to reflect:



First Transaction



| |  | the elimination of $750,400 of software license revenue of the approximately $1.5 million originally recorded in the third fiscal quarter ended June 30, 2002 to reflect the proceeds
not received during the quarter;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the recognition of $632,000 of software license revenue in the fourth fiscal quarter ended September 30, 2002 to reflect the proceeds received during the quarter; and
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the recognition of $118,000 of maintenance revenue ratably over the four fiscal quarters commencing July 1, 2003 and ending June 30, 2004 during which periods the maintenance
revenues were earned, the proceeds for which were received in the fourth fiscal quarter ended September 30, 2002;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Second Transaction



| |  | the elimination of $750,000 of software license, maintenance and deferred revenue in the fourth fiscal quarter ended September 30, 2003 because no proceeds were received during the
quarter;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the recognition of $273,000 of software license revenue in the fourth fiscal quarter ended September 30, 2004 to reflect the proceeds received during the quarter; and
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the recognition of $64,000 of maintenance revenue ratably over the five fiscal quarters commencing July 1, 2004 and ending September 30, 2005 during which periods the maintenance
revenues will be earned, the proceeds for which were received in the fourth fiscal quarter ended September 30, 2004.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In addition, we will recognize $262,500 of software license revenue in the first fiscal quarter of fiscal year 2005 ended December 31, 2004, reflecting additional proceeds received
during the first fiscal quarter of fiscal year 2005 with respect to the second transaction.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As a result of the Internal Accounting Review, we will be recognizing approximately $2.1 million of software license and maintenance revenue with respect to the two transactions, which is the total amount of proceeds
that we have received from the software reseller. This amount is $150,000 less than originally recorded because during the fourth fiscal quarter of fiscal year 2004, we entered into an agreement with the software reseller to reduce the amount
payable with respect to the second transaction by $150,000. This agreement confirms that we have satisfied all of our outstanding obligations and that the reseller will make no additional payments with respect to this sale.



Other Significant Transactions Requiring Restatement



During the course of our review of the financial statements for fiscal years 2002, 2003 and
the first and second fiscal quarters of 2004, we determined that other transactions required adjustment in order for our financial statements to conform more properly to Generally Accepted Accounting Principles (GAAP). These adjustments
are described below.



Marketing Incentive
Programs



We have participated with certain of our distributor and
reseller customers in marketing incentive programs that have resulted in the provision of rebates, credits and discounts to these customers. These transactions were originally recorded as marketing expenses. We have determined that these rebates,
credits and discounts should be accounted for in accordance with Emerging Issues Task Force (EITF) Issue No. 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products),
as a reduction to revenues and not as marketing expenses. As a result, for the fiscal years ended September 30, 2002 and 2003, we are reducing revenues by $935,000 and $824,000, respectively, and making offsetting reductions to marketing expenses
during the same periods. The adjustments to record these transactions properly are being made on a quarterly basis. For the three months ended December 31, 2003 and March 31, 2004, we are reducing revenues by $289,000 and $174,000, respectively, and
making offsetting reductions to marketing expenses during these periods. These adjustments do not change our previously reported net loss for any period.





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Rent Expense



We determined that we recorded expenses in error relating to a rental obligation for which we previously had accrued a charge in conjunction
with an acquisition. We are correcting this error by reversing (i) $109,000 of operating expenses for fiscal year ended September 30, 2002; (ii) $50,000 of operating expenses for the fiscal year ended September 30, 2003; and (iii) $10,000 and
$12,000 of operating expenses for the three months ended December 31, 2003 and March 31, 2004, respectively. These adjustments will reduce our previously reported net loss or increase our previously reported net income for these periods. These
adjustments are being recorded on a quarterly basis.



Income Tax Expense



We are reducing our income tax expense by
$200,000 for the fiscal quarter ended June 30, 2002 to reflect the receipt of an income tax refund for which there is no associated liability. This adjustment will reduce our net loss for the three months and fiscal year ended June 30, 2002 and
September 30, 2002, respectively.



Inventory



We determined that manufacturing overhead had not
been properly applied to cost of sales and ending inventory for prior fiscal periods. As a result, inventory valuation was (i) understated by $242,000 at September 30, 2002; (ii) overstated by $320,000 at September 30, 2003; and (iii) and overstated
by $16,000 for the first and second fiscal quarters of fiscal years 2004. Accordingly, cost of revenues increased/(decreased) by ($242,000), $320,000, and $16,000 for the fiscal years ended September 30, 2002 and 2003, and for the first and second
fiscal quarters of fiscal year 2004, respectively, as a result of these adjustments. The adjustments to properly record manufacturing overhead are being recorded on a quarterly basis, and this summary describes the annual effect of these
adjustments.



We determined that the Reserve for Excess and Obsolete Inventory
for prior years was inadequate based on information that was known at the end of these periods. The effect of these adjustments was to decrease the net value of inventory by $385,000 and $155,000 at September 30, 2002 and 2003, respectively. Cost of
Revenues increased/(decreased) by $385,000, ($230,000), and ($155,000) for the years ended September 30, 2002, 2003 and 2004, respectively, as a result of these adjustments.



Amortization of Other Intangible Assets



We determined that the amortization of other intangible assets, with identifiable lives,
related to the acquisitions of Cayman and JadeSail were included incorrectly in operating expenses. We have reclassified the expenses to cost of revenue for fiscal years 2002 and 2003 and for the first quarter of fiscal year 2004. Cost of revenues
increased by $288,000 per quarter or $1.2 million for fiscal years ended September 30, 2002 and 2003. For the first quarter of fiscal year 2004, cost of revenues increased by $300,000. Although these adjustments do not impact our previously reported
net loss/income for these periods, they will reduce the gross margins reported for these periods.



Summary



On January 25, 2005,
the Audit Committee met with the Companys Interim Senior Vice President and Chief Financial Officer and BPM to review the effect on the Companys previously issued financial statements of: (i) the findings of the Internal Accounting
Review, (ii) the other significant transactions requiring adjustment, as described above, and (iii) and certain other adjustments, including other revenue and expense transactions that were overstated in certain periods and understated in other
periods. While the amounts associated with these other adjustments are relatively small, we believe that it is appropriate to record them as part of these restatements so that our financial statements are as accurate as possible. The Audit Committee
approved the adjustments and resulting restatements to previously issued financial statements.





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The net effect of all of the restatement adjustments is to:



| |  | decrease our net loss by approximately $23,000 during the fiscal quarter ended March 31, 2004;
|- |  | ----------------------------------------------------------------------------------------------



| |  | increase our net income by approximately $34,000 during the fiscal quarter ended December 31, 2003;
|- |  | ---------------------------------------------------------------------------------------------------



| |  | increase our net loss by approximately $545,000 for the fiscal year ended September 30, 2003; and
|- |  | -------------------------------------------------------------------------------------------------



| |  | increase our net loss by approximately $9,000 for the fiscal year ended September 30, 2002.
|- |  | -------------------------------------------------------------------------------------------



| |  | As described above, as a result of the restatement adjustments, we also will recognize $262,500 of software license revenue in the first fiscal quarter of fiscal year 2005 ended
December 31, 2004, reflecting additional proceeds received during the first fiscal quarter of fiscal year 2005.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In the 2004 10-K we have provided tables that set forth certain unaudited quarterly results of operations data for the twelve quarters ended September 30, 2004, both as
previously reported and as restated.



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PART I  FINANCIAL INFORMATION



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Some of the information in this Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by
forward-looking words such as may, will, should, expect, anticipate, potential, believe, estimate, intends and continue or
similar words. You should read statements that contain these words carefully because they: (i) discuss our expectations about our future performance; (ii) contain projections of our future operating results or of our future financial condition; or
(iii) state other forward-looking information. There will be events in the future that we are not able to predict or over which we have no control, which may adversely affect our future results of operations, financial condition or stock
price. The risk factors described in this Form 10-Q, as well as any cautionary language in this Form 10-Q, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we described
in our forward-looking statements. You should be aware that the occurrence of any of the risks, uncertainties, or events described in this Form 10-Q could seriously harm our business and that, upon the occurrence of any of these events, the price of
our common stock could decline. All forward-looking statements included in this Form 10-Q are based on information available to us on the date hereof. We assume no obligation to update any such forward-looking statements.



Company Overview



We develop, market and support broadband and wireless (Wi-Fi) products and services that enable our carrier and service provider customers
to simplify and enhance the delivery of broadband services to their residential and business-class customers. Our product and service offerings enable carriers and broadband service providers to (i) deliver to their customers feature-rich broadband
modems, routers and gateways, (ii) utilize software that allows remote management of equipment located at their customers premises, and (iii) provide value added services to enhance revenue generation and reduce support costs for their
customers. Our broadband modems, routers and gateways are installed by the customers of carrier and broadband service providers to obtain high-speed, always-on access to the Internet. Our digital subscriber line (DSL) and other broadband gateways
are often bundled with virtual private networking (VPN) capabilities that allow more secure communications over the Internet, firewall protection, parental controls, hot spot access, Web content filtering, combined voice and data services, hosting
of web sites that we call eSites, and hosting of web stores that we call eStores. Our Netopia Broadband Server (NBBS) software platform products enable remote support and management of installed broadband gateways and centralized service
provisioning for value-added broadband services such as parental controls or hot spot access. This architecture allows carriers and broadband service providers to provide support to their customers on a remote basis and potentially reduce the cost
of installation and broadband service provisioning over the lifetime of the customer. We also offer Timbuktu and eCare software products for enterprise help desk customers and IT organizations. These products allow help desks to provide support on a
remote basis when computer users experience problems or require additional software upgrades for their desktop or laptop computers.



Broadband Equipment. We have developed a comprehensive family of broadband Internet modems, routers and gateways, which allow the transport of
high-speed data over carrier networks including the local copper loop and new deployments of fiber-optic networks. This family of products serves many of wide area network (WAN) interfaces including DSL, Ethernet and T1, and LAN interfaces including
Wi-Fi and Ethernet. Our broadband Internet products are designed to deliver high performance, excellent reliability, scalability, and affordability, and to be a platform from which our carrier and service provider customers can offer their customers
additional services and applications. We believe key components to our success are comprehensive interoperability with leading central office DSL equipment, a common firmware platform across all versions of our broadband Internet products, and
technology such as our 3-D Reach technology which
we believe gives our Wi-Fi products greater and more reliable wireless coverage than that of many of our competitors. The substantial majority of our revenues are generated



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from sales of our broadband Internet products, in particular our DSL modems, routers and gateways. During the three and nine months ended June 30, 2004 and
2003, revenue from the sale of our broadband Internet products have accounted for 84%, 84%, 79% and 71%, respectively, of our total revenues. When reading our condensed consolidated statement of operations, revenues and cost of revenues related to
the sale of our Broadband equipment are classified as broadband equipment.



Broadband Software and Services. Our service delivery platform includes the Netopia Broadband Server software (NBBS), which enables carrier and service providers to manage remotely Netopia and other third party devices and to
deliver value-added broadband services. The NBBS platform includes modules that perform different functions: Zero Touch provisioning for the initial installation of broadband equipment at the customer premises and ongoing remote
administration and support; Hot Spot Manager for the provisioning, authentication and management of hot spot venue access; Parental Controls for Web content filtering and email and chat management; VPN Policy Manager for the setup and administration
of secure VPN enabled WAN networks. Our eCommerce solution provides no assembly required Web sites and online stores that we call eSites and eStores, with a wide variety of vertical market content packages to suit many needs, from
franchisees to sole proprietors. Our systems management software includes Timbuktu, a systems management tool providing remote computer control, configuration, support and file transfer. We hold one United States patent relating to Timbuktu systems
management software. The term of this patent is through August 2010. During the three and nine months ended June 30, 2004 and 2003, revenue from the sale of our broadband services have accounted for 16%, 16%, 21% and 29%, respectively, of our total
revenues. When reading our condensed consolidated statement of operations, revenues and cost of revenues related to the sale of our broadband software and services are classified as Broadband software and services.



We primarily market and sell our products in the United States, Canada, Europe and the Asia
Pacific region through a field sales organization and through selected distributors. Our broadband equipment products are generally sold directly to our carrier and service provider customers or in some cases to distributors who then resell our
products. Our broadband software and services products are generally sold directly to our customers. We primarily sell our products to:



| |  |  | Telecommunication carriers, including: incumbent local exchange carriers (ILECs), such as Swisscom AG, SBC Communications Inc., BellSouth Telecommunications, Inc., eircom Ltd.,
Belgacom and Verizon Communications Inc.; competitive local exchange carriers (CLECs), including Covad Communications Group, Inc. and NextGenTel; and Internet service providers (ISPs) and managed service providers (MSPs), including EarthLink, Inc.,
MegaPath Networks, Inc. and Netifice Communications, Inc.;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Distributors, including: Ingram Micro Inc. and Tech Data Corporation; and
| | - |  | -------------------------------------------------------------------------



| |  |  | Directly to end-users.
| | - |  | ----------------------



We expect that the success of our operations will remain substantially dependent upon our ability to develop and enhance products that meet the needs of both the residential and business market for ADSL and Wi-Fi
services and requirements of our ILEC customers. Our major customers are significantly larger than we are, and are able to exert a high degree of influence over our business. For example, our larger customers may be able to reschedule or cancel
orders without significant penalty and may force lengthy approval and purchase processes before purchasing our products.



Critical Accounting Policies and Estimates



Managements discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been
prepared in accordance with United States generally accepted accounting principles. We review the accounting policies used in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our processes used to develop estimates, including those related to revenue, accounts receivable, inventories,
investments, intangible assets and goodwill. We base our



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estimates on historical experience, expectations of future results, and on various other assumptions that are believed to be reasonable for making judgments
about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. These estimates
and judgments are reviewed by management on an ongoing basis. The Audit Committee reviews any changes in our methodology for arriving at our estimates, and discusses the appropriateness of any such changes with management and our independent
auditors on a quarterly basis. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.



Revenue Recognition. We generally recognize revenue from the sale of broadband
Internet equipment at the time of shipment to a third party customer when (a) persuasive evidence of an arrangement exists; (b) the price to the customer is fixed or determinable; (c) the customer is obligated to pay us and the obligation is not
contingent on resale of the product; (d) the customers obligation to us would not be changed in the event of theft or physical destruction or damage of the product; (e) we do not have significant obligations for future performance to directly
bring about resale of the product by the customer; and (f) the customer takes title of the goods. However, determining whether and when some of these criteria have been satisfied often involve assumptions and judgments that can have significant
impact on the timing and amount of revenue we report. At the date of shipment, assuming that the revenue recognition criteria specified above is met, we provide for an estimate of returns and warranty expense based on historical experience of
returns of similar products and warranty costs incurred, respectively.



We
recognize software revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, and SEC Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition. We generally
have multiple element arrangements for our software revenue including software licenses and maintenance. We allocate the arrangement fee to each of the elements based on the residual method utilizing vendor specific objective evidence
(VSOE) for the undelivered elements, regardless of any separate prices stated within the contract for each element. VSOE for maintenance is generally based on the price the customer would pay when sold separately. Software license
revenue is recognized when a non-cancelable license agreement has been signed or a properly authorized firm purchase order is received and the customer acknowledges an unconditional obligation to pay, the software product has been delivered, there
are no uncertainties surrounding product acceptance, the fees are fixed and determinable, and collection is considered probable. Maintenance revenues, including revenues included in multiple element arrangements, are deferred and recognized ratably
over the related contract period, generally twelve months.



We recognize
revenue from long-term software development contracts using the percentage of completion method in accordance with SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. For these contracts, which
involve significant implementation or other services which are essential to the functionality of the software and which are reasonably estimable, the license and services revenue is recognized over the period of each implementation, primarily using
the percentage-of-completion method. Labor hours incurred are used as the measure of progress towards completion. A provision for estimated losses on engagements is made in the period in which the loss becomes probable and can be reasonably
estimated. In cases where a sale of a license does not include implementation services, as in the sale of additional seats, revenue is recorded upon delivery with an appropriate deferral for maintenance services, if applicable, provided all of the
other relevant conditions have been met. On a quarterly basis, we review costs incurred to date along with an estimate to complete and compare the sum of such amounts against the revenue expected from the arrangement to determine the need for an
accrual for loss contracts.



We apply the provisions of Emerging Issues Task
Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, to arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. Our enhanced web site services
generally involve the delivery of multiple services. We allocate a portion of the arrangement fee to the undelivered element, generally web site hosting, based on the residual method utilizing VSOE for the undelivered elements, regardless of any
separate prices stated within the contract for each element. VSOE for hosting is based on the price the



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customer would pay when sold separately. Fair value for the delivered elements, primarily fulfillment services, is based on the residual amount of the total
arrangement fees after deducting the VSOE for the undelivered elements. Fulfillment revenue is recognized when a properly authorized firm purchase order is received and the customer acknowledges an unconditional obligation to pay, there are no
uncertainties surrounding product acceptance, the fees are fixed and determinable, collection is considered probable and the fulfillment has been completed. Hosting revenues are deferred and recognized ratably over the related service period,
generally twelve months. We record unearned revenue for these arrangements when cash has been received from the customer and the arrangement does not qualify for revenue recognition under our revenue recognition policy.



We record unearned revenue for software and service arrangements when cash has been received
from the customer and the arrangement does not qualify for revenue recognition under our revenue recognition policy. We record accounts receivable for software and service arrangements when the arrangement qualifies for revenue recognition and cash
or other consideration has not been received from the customer.



We have
adopted the provisions of EITF 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products), for the accounting treatment of marketing incentive programs that have resulted in the
provision of rebates, credits and discounts given to our customers directly or indirectly. We presume such incentive programs and rebates, credits and discounts to be a reduction of the selling prices of the our products and/or services and,
therefore, are characterized as a reduction of revenue when recognized in our Consolidated Financial Statements.



Goodwill. On October 1, 2001, we adopted Statement of Financial Accounting Standards (SFAS) No. 142,Goodwill and Other Intangible Assets, which
provides that goodwill should not be amortized but instead be tested for impairment annually at the reporting unit level. The impairment testing is performed in two steps: (i) the determination of impairment, based upon the fair value of a reporting
unit as compared to its carrying value, and (ii) if there is an indication of impairment, this step measures the amount of impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill. We perform our
annual impairment test, as required by SFAS No. 142, in our fiscal fourth quarter.



Impairment of Long-Lived Assets, Including Other Intangible Assets. We adopted the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, on October 1, 2001. SFAS No. 144 serves to clarify
and further define the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.We evaluate our long-lived assets, including other intangible assets in accordance with SFAS
No. 144 and test our long-lived assets and other intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to the estimated undiscounted future net cash flows expected to be generated by the asset group that represents the lowest level for which identifiable cash flows exist. If an asset group
is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets and is allocated to the long-lived assets of the asset group on a pro rata basis. Fair value is
estimated using the discounted cash flow method. Assets to be disposed of are reported at the lower of carrying values or fair values, less costs of disposal.



Allowance for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make
required payments and deemed uncollectible. Management specifically analyzes the aging of accounts receivable and also analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in
customer payment terms, when evaluating the adequacy of the allowance for doubtful accounts in any accounting period. We will continue to monitor our customers ability to pay throughout the term of the applicable arrangement and will adjust
the provision for bad debt allowance or defer revenue recognition, as appropriate. If the financial condition of our customers or channel partners were to deteriorate, resulting in an impairment of their ability to make payments, additional
allowances may be required.



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Excess and Obsolete Inventory. We assess the need for reserves on excess and obsolete inventory based upon monthly
forward projections of sales of products. Inventories are recorded at the lower of cost (first-in, first-out method) or market. Cost includes material costs and applicable manufacturing overheads. The provision for potentially obsolete or slow
moving inventory is made based upon managements analysis of inventory levels, forecasted sales, expected product life cycles and market conditions. Once inventory is reserved, the reserve can only be relieved by the subsequent sale or
scrapping of the inventory.



Liquidity and Capital Resources



The following sections discuss the effects of changes in our balance
sheets, cash flows and commitments on our liquidity and capital resources. As of June 30, 2004, our principal source of liquidity included cash and cash equivalents in the amount of $23.5 million, a credit facility with a maximum borrowing capacity
of up to $11.9 million from which we had no outstanding borrowings at June 30, 2004, and two term loans from which we had a total amounts outstanding of approximately $0.2 million.



Cash and Cash Equivalents. The following table sets forth our cash and cash equivalents as of June 30, 2004 and September 30, 2003.



|                          |  |              |        |                    |   |                     |  |   |       |  |   |  
|------------------------- |  | ------------ | ------ | ------------------ | - | ------------------- |  | - | ----- |  | - | -
|                          |  | June 30,2004 |        | September 30, 2003 |   | Increase/(decrease) | 
|Cash and cash equivalents |  | $            | 23,535 |                    | $ | 22,208              |  | $ | 1,327 |  | 6 | %



For the nine months ended June 30,
2004, cash and cash equivalents increased primarily due to the proceeds we received from the issuance of our common stock offset by cash used in our operating activities and capital equipment purchases.



Net Cash Used in Operating Activities



During the nine months ended June 30, 2004, our operating activities utilized $4.6 million
of cash. Excluding the changes in operating assets and liabilities, our operating activities generated $0.1 million of cash primarily due to our depreciation and amortization. Changes in our operating assets and liabilities used $5.2 million of cash
primarily as a result of increased inventory purchases and increased accounts payable balances and partially offset by decreased deposit and other assets. Our inventory increased as a result of increased ocean shipments of in-transit finished goods
and a greater amount of shipments billed Delivered Duty Paid (DDP), which does not allow the Company to recognize the sale and receivable until the product is received by the customer and to an increase in sales.



Net Cash Used in Investing Activities



During the nine months ended June 30, 2004, investing activities used approximately $1.7
million of cash, of which $1.3 million was related to the purchase of capital equipment primarily for use in our development and manufacturing operations.



Net Cash Provided from Financing Activities



During the nine months ended June 30, 2004, we generated $7.7 million of cash, primarily due to the proceeds we received from the issuance of our common stock, offset by
payments to the Companys term loans.



Commitments



As of June 30, 2004, we had commitments that consisted of facilities and equipment under
operating lease agreements, borrowings under term loans and purchase commitments primarily for inventory. Purchase obligations are comprised of purchase commitments with our contract manufacturers. Our



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contract manufacturers procure component inventory on our behalf based on our production orders. We are obligated to purchase component inventory that the
contract manufacturer procures in accordance with the orders, unless cancellation is given within applicable lead times. These commitments and obligations are reflected in our financial statements once goods or services have been received or
payments related to the obligations become due. The following is a schedule of our future minimum cash payments with respect to such commitments.



|                                         |  |                |        |      |   |       |  |      |     |      |   |            |  |        |     |  |   |   |  |   |       
|---------------------------------------- |  | -------------- | ------ | ---- | - | ----- |  | ---- | --- | ---- | - | ---------- |  | ------ | --- |  | - | - |  | - | ------
|Fiscal years ended September 30,         |  | 2004 (a)       |        | 2005 |   | 2006  |  | 2007 |     | 2008 |   | Thereafter |  | Totals
|                                         |  | (in thousands)
|Purchase obligations                     |  | $              | 20,446 |      | $ |      |  | $    |    |      | $ |           |  | $      |    |  | $ |  |  | $ | 20,446
|Facility and operating lease commitments |  |                | 380    |      |   | 1,291 |  |      | 938 |      |   | 966        |  |        | 650 |  |   |  |  |   | 4,225 
|Payments under term loans                |  |                | 62     |      |   | 104   |  |      |    |      |   |           |  |        |    |  |   |  |  |   | 166   
|                                         |  |                |        |      |   |       |  |      |     |      |   |            |  |        |     |  |   |   |  |   |      
|                                         |  |                |        |      |   |       |  |      |     |      |   |            |  |        |     |  |   |   |  |   |       
|Totals                                   |  | $              | 20,888 |      | $ | 1,395 |  | $    | 938 |      | $ | 966        |  | $      | 650 |  | $ |  |  | $ | 24,837
|                                         |  |                |        |      |   |       |  |      |     |      |   |            |  |        |     |  |   |   |  |   |       

---

|(a) | Represents cash commitments for the remaining 3 months of fiscal year 2004.
|--- | ---------------------------------------------------------------------------



At June 30, 2004, we had no borrowings under our credit facility and had an outstanding balance of approximately $0.2 million borrowed under our term loans. We currently
believe we have enough cash and cash equivalents and that our business activities will be generate sufficient cash to cover our working capital needs for at least the next twelve months. To the extent our business does not generate sufficient cash
to cover our working capital needs, we would utilize our credit facility, which currently has a maximum borrowing capacity of up to $15.0 million. As of June 30, 2004, our borrowing availability under our credit facility which was approximately
$11.9 million and we did not have any material commitments for capital expenditures.



Trade Accounts Receivable, Net. The following table sets forth our trade accounts receivables, net as of June 30, 2004 and September 30, 2003 and quarterly day sales outstanding calculations.



|                                 |  |                |         |      |   |        
|-------------------------------- |  | -------------- | ------- | ---- | - | -------
|Fiscal years ended September 30, |  | 2004           |         | 2003
|                                 |  | (in thousands)
|Trade accounts receivable, net   |  | $              | 16,296  |      | $ | 16,062 
|Days sales outstanding (DSO)     |  |                | 58 days |      |   | 59 days



Changes in our trade accounts
receivable, net balances and days sales outstanding are primarily due to the timing of sales within the quarter, increased revenues and collections performance.



Inventories. The following table sets forth our inventories as of June 30, 2004 and September 30, 2003.



|                |  |                  |       |                    |   |                     |  |   |       |  |    |  
|--------------- |  | ---------------- | ----- | ------------------ | - | ------------------- |  | - | ----- |  | -- | -
|                |  | June 30, 2004    |       | September 30, 2003 |   | Increase/(decrease) | 
|                |  |                  |       | $                  |   | %                   | 
|                |  | ($ in thousands) |      
|Inventory       |  | $                | 8,946 |                    | $ | 5,738               |  | $ | 3,208 |  | 56 | %
|Inventory turns |  |                  | 4.8   |                    |   | 7.9                 |  |   |       |  |    |  



Inventory consists primarily of raw
material, work in process, and finished goods. Inventory increased primarily due to an increase of finished goods inventory, which included ocean shipments of in-transit finish goods for which title had not transferred to the customers. Inventory
levels may increase or decrease in the future if customers do not provide accurate forecasts, sell-through and on-hand inventory information, thereby impairing ability to correctly forecast expected customer demand, or if customers defer or
otherwise delay purchases or shipments. As a result of rapidly changing technology and customer requirements, the Company continues to closely monitor its inventory requirements and balance the need to maintain adequate inventory levels to ensure
competitive lead times against the risk of inventory obsolescence.



Page 27



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##### Table of Contents

Results of Operations for the Three and Nine Months Ended June 30, 2004 and 2003



The following table sets forth for the periods indicated certain unaudited condensed
consolidated statement of operations data. To help understand the data, each item of data is also shown as a percentage of total revenues along with the dollar and percentage change from the same period in the prior fiscal year. This data has been
derived from the consolidated financial statements elsewhere in this Form 10-Q, and in the 2004 10-K, in which we describe the restatement adjustments for the same period in the prior year. The operating results for any period should not be
considered indicative of results for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-Q and in the 2004 10-K.



|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|--------------------------------------------------- |  | --------------------------- | ------ | - | --------------------------- | --- | - | -------------------------- | --------------- | ------ | ---------------------------- | --------------- | --- | - |  | ---- | - |  | - | ------ | - |  | --- | - |  | - | ------ | - |  | --- | - |  | ---- | -
|                                                    |  | Three months ended June 30, |        |   | Percentincrease/ (decrease) |     |   | Nine months ended June 30, |                 |        | Percent increase/ (decrease) |                
|                                                    |  | 2004                        |        |   | 2003 (Restated)             |     |   |                            | 2004 (Restated) |        |                              | 2003 (Restated) |     |  
|                                                    |  | (in thousands)              |        |   |                             |     |   | (in thousands)             |                 |        |                              |                
|REVENUES:                                           |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Broadband equipment                                 |  |                             | 21,891 |   |                             | 86  | % |                            |                 | 17,718 |                              |                 | 81  | % |  | 24   | % |  |   | 63,426 |   |  | 84  | % |  |   | 46,771 |   |  | 78  | % |  | 36   | %
|Broadband software and services                     |  |                             | 3,543  |   |                             | 14  | % |                            |                 | 4,114  |                              |                 | 19  | % |  | -14  | % |  |   | 12,074 |   |  | 16  | % |  |   | 13,233 |   |  | 22  | % |  | -9   | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Total revenues                                      |  |                             | 25,434 |   |                             | 100 | % |                            |                 | 21,832 |                              |                 | 100 | % |  | 16   | % |  |   | 75,500 |   |  | 100 | % |  |   | 60,004 |   |  | 100 | % |  | 26   | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|COST OF REVENUES:                                   |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Broadband equipment                                 |  |                             | 16,757 |   |                             | 66  | % |                            |                 | 12,808 |                              |                 | 59  | % |  | 31   | % |  |   | 45,780 |   |  | 61  | % |  |   | 34,671 |   |  | 58  | % |  | 32   | %
|Broadband software and services                     |  |                             | 267    |   |                             | 1   | % |                            |                 | 316    |                              |                 | 1   | % |  | -16  | % |  |   | 706    |   |  | 1   | % |  |   | 1,090  |   |  | 2   | % |  | -35  | %
|Amortization of acquired technology                 |  |                             | 300    |   |                             | 1   | % |                            |                 | 288    |                              |                 | 1   | % |  | 100  | % |  |   | 900    |   |  | 1   | % |  |   | 864    |   |  | 1   | % |  | 4    | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Total cost of revenues                              |  |                             | 17,324 |   |                             | 68  | % |                            |                 | 13,412 |                              |                 | 61  | % |  | 29   | % |  |   | 47,386 |   |  | 63  | % |  |   | 36,625 |   |  | 61  | % |  | 29   | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|GROSS PROFIT                                        |  |                             | 8,110  |   |                             | 32  | % |                            |                 | 8,420  |                              |                 | 39  | % |  | -4   | % |  |   | 28,114 |   |  | 37  | % |  |   | 23,379 |   |  | 39  | % |  | 20   | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |       
|OPERATING EXPENSES:                                 |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Research and development                            |  |                             | 3,846  |   |                             | 15  | % |                            |                 | 3,764  |                              |                 | 17  | % |  | 2    | % |  |   | 11,854 |   |  | 16  | % |  |   | 11,758 |   |  | 20  | % |  | 1    | %
|Research and development project cancellation costs |  |                             |       |   |                             | 0   | % |                            |                 |       |                              |                 | 0   | % |  | 0    | % |  |   |       |   |  | 0   | % |  |   | 606    |   |  | 1   | % |  | -100 | %
|Selling and marketing                               |  |                             | 5,199  |   |                             | 20  | % |                            |                 | 4,855  |                              |                 | 22  | % |  | 7    | % |  |   | 15,262 |   |  | 20  | % |  |   | 15,265 |   |  | 25  | % |  | 0    | %
|General and administrative                          |  |                             | 1,184  |   |                             | 5   | % |                            |                 | 961    |                              |                 | 4   | % |  | 23   | % |  |   | 3,591  |   |  | 5   | % |  |   | 3,464  |   |  | 6   | % |  | 4    | %
|Amortization of intangible assets                   |  |                             | 86     |   |                             | 0   | % |                            |                 | 86     |                              |                 | 0   | % |  | 0    | % |  |   | 259    |   |  | 0   | % |  |   | 258    |   |  | 0   | % |  | 0    | %
|Restructuring costs                                 |  |                             |       |   |                             | 0   | % |                            |                 | 130    |                              |                 | 1   | % |  | -100 | % |  |   |       |   |  | 0   | % |  |   | 472    |   |  | 1   | % |  | -100 | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Total operating expenses                            |  |                             | 10,315 |   |                             | 41  | % |                            |                 | 9,796  |                              |                 | 45  | % |  | 5    | % |  |   | 30,966 |   |  | 41  | % |  |   | 31,823 |   |  | 53  | % |  | -3   | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|OPERATING LOSS                                      |  |                             | (2,205 | ) |                             | -9  | % |                            |                 | (1,376 | )                            |                 | -6  | % |  | 60   | % |  |   | (2,852 | ) |  | -4  | % |  |   | (8,444 | ) |  | -14 | % |  | -66  | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |       
|Other income (loss), net                            |  |                             | (52    | ) |                             | 0   | % |                            |                 | (3     | )                            |                 | 0   | % |  | 1633 | % |  |   | 193    |   |  | 0   | % |  |   | (472   | ) |  | -1  | % |  | -141 | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Income (loss) before income taxes                   |  |                             | (2,257 | ) |                             | -9  | % |                            |                 | (1,379 | )                            |                 | -6  | % |  | 64   | % |  |   | (2,659 | ) |  | -4  | % |  |   | (8,916 | ) |  | -15 | % |  | -70  | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Provision for income taxes                          |  |                             | (19    | ) |                             | 0   | % |                            |                 |       |                              |                 | 0   | % |  | -100 | % |  |   | 65     |   |  | 0   | % |  |   |       |   |  | 0   | % |  | 100  | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|NET LOSS                                            |  | $                           | (2,276 | ) |                             | -9  | % |                            | $               | (1,379 | )                            |                 | -6  | % |  | 65   | % |  | $ | (2,724 | ) |  | -4  | % |  | $ | (8,916 | ) |  | -15 | % |  | -69  | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Per share data, net income (loss):                  |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Basic and diluted net loss per share                |  | $                           | (0.09  | ) |                             |     |   |                            | $               | (0.07  | )                            |                 |     |   |  | 38   |   |  | $ | (0.12  | ) |  |     |   |  | $ | (0.47  | ) |  |     |   |  | -75  | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  
|Shares used in the per share calculations           |  |                             | 24,033 |   |                             |     |   |                            |                 | 19,370 |                              |                 |     |   |  | 14   | % |  |   | 23,247 |   |  |     |   |  |   | 19,059 |   |  |     |   |  | 22   | %
|                                                    |  |                             |        |   |                             |     |   |                            |                 |        |                              |                 |     |   |  |      |   |  |   |        |   |  |     |   |  |   |        |   |  |     |   |  |      |  



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##### Table of Contents

REVENUES



Total revenues for the three and nine months ended June 30, 2004 increased from the three and nine months ended June 30, 2003 primarily due to increased revenues from the
sale of our broadband equipment products partially offset by reduced revenues from the sale of our broadband software and services.



Broadband Equipment. Broadband equipment revenues increased for the three and nine months ended June 30, 2004 from the three and nine months ended June 30, 2003
primarily due to increased international volumes of ADSL broadband equipment These increases were partially offset by the effect of declining average unit selling prices primarily as a result of the mix of products sold, price competition from
foreign and domestic competitors, and customer driven demands. The mix of broadband equipment sales changes as we continue to win new customers, which serve the residential market for ADSL broadband Internet services. Residential-class products, and
ADSL products in general generate a lower average unit-selling price than similar business-class products. We believe that increased sales volumes from new customers and new opportunities with existing customers will help offset any declines in
revenues resulting from lower ASPs. See the Product Volume and Average Selling Price Information section below, which sets forth our volumes and average selling prices.



Broadband software and services. Broadband software and services revenues decreased for the three and nine months ended June 30, 2004
from the three and nine months ended June 30, 2003 because the three and nine months ended June 30, 2003 included revenue from a software integration project that was completed during the three months ended September 30, 2003 as well as reduced
revenues from the licensing of our help-desk products.



Product Volumes and
Average Selling Price Information



The following tables sets forth for the
periods indicated, volumes and average selling prices, excluding accessories, of our broadband equipment products. The decline in average selling prices resulted from increased unit sales of lower price residential class products as compared to
higher price business class products, as well as competitive market conditions generally. We expect that average-selling prices will continue to decline.



|                            |  |      |         |         |   |                     |   |   |         |   |  |     |   
|--------------------------- |  | ---- | ------- | ------- | - | ------------------- | - | - | ------- | - |  | --- | --
|                            |  | 2004 |         | 2003    |   | Increase/(decrease) |  
|Three months ended June 30, |  |      |         | Units/$ |   |                     | % |  
|                            |  |      |         |         |   |                     |   |   |         |   |  |     |   
|Product volumes             |  |      | 236,977 |         |   | 101,826             |   |   | 135,151 |   |  | 133 | % 
|Average selling prices      |  | $    | 89      |         | $ | 144                 |   | $ | (55     | ) |  | (38 | )%
|                            |  |      |         |        
|Nine months ended June 30,  |  |      |         |         |   |                     |   |   |         |  
|Product volumes             |  |      | 711,132 |         |   | 186,532             |   |   | 524,600 |   |  | 281 | % 
|Average selling prices      |  | $    | 88      |         | $ | 156                 |   | $ | (68     | ) |  | (44 | )%



COST OF REVENUES



Cost of revenues consists primarily of material costs of broadband equipment products. Total
cost of revenues increased for the three and nine months ended June 30, 2004 from the three and nine months ended June 30, 2003, primarily as a result of increased sales volumes of ADSL broadband equipment and component cost increases. To the extent
that component costs continue to increase as a result of improved general economic conditions and customer demand, we expect cost of revenues as a percent of total revenues may continue to increase in the future. To help offset any cost increases,
we intend to leverage the increasing volumes with our contract manufacturers to reduce their costs, and to continue to pursue product redesigns and alternative, lower cost components for our products in an effort to reduce our overall product
material costs.



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##### Table of Contents

Gross Margin



Gross margins for the three and nine months ended June 30, 2004 were 31.9% and 37.2%, respectively compared to 38.6% and 39.0%, respectively for the three and nine months
ended June 30, 2003. Included in the cost of revenues for the three and nine months ended June 30, 2004 was the amortization of acquired technologies of $0.3 million and $0.9 million, respectively, reducing the gross margins by 1.2% for both the
three and nine month periods. The decrease in gross margins was primarily the result of lower average selling prices and with higher component costs.



Broadband equipment. Broadband equipment gross margins decreased to 22.1% and 27.8%, respectively for the three and nine months ended June 30, 2004 from 27.7% and
25.9%, respectively, for the same periods in the prior year. The decrease was primarily due to average selling price decreases, increased component and product costs and the inclusion of amortization expense related to acquired technologies. The
primary factors influencing the Companys broadband equipment gross margins are product mix, ability to reduce product costs based on negotiations with vendors, increased cost absorption resulting from increased volumes, and the timing of these
cost reductions relative to market pricing conditions.



Broadband software
and services. Broadband software and services gross margins for the three and nine months ended June 30, 2004 were 92.1% and 94.2%, respectively, compared to 92.3% and 91.8%, respectively, for the three and nine months ended June 30, 2003. The
decrease in gross margins was primarily the result of fixed labor costs associated with decreased revenues.



Broadband equipment products have a lower average gross margin than broadband software and services products. Accordingly, to the extent we sell more broadband equipment, overall gross margins will be lower. In the
past, gross margins have varied significantly and will likely vary significantly in the future. Our gross margins depend primarily on:



| |  |  | The continued shift in mix towards a greater percentage of sales of our broadband equipment than of broadband software and services, which typically have higher gross margins;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pricing strategies;
| | - |  | -------------------



| |  |  | Increased sales of residential-class broadband equipment which have lower average selling prices than business-class broadband equipment;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Product and material cost changes;
| | - |  | ----------------------------------



| |  |  | The cost of personnel and equipment associated with manufacturing support and manufacturing engineering;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | Provision for excess inventory;
| | - |  | -------------------------------



| |  |  | New versions of existing products; and
| | - |  | --------------------------------------



| |  |  | External market factors, including but not limited to, price competition.
| | - |  | -------------------------------------------------------------------------



OPERATING EXPENSES



Research and Development. Research and development expenses consist primarily of employee related expenses, depreciation and amortization, development related expenses such as product prototyping, design and
testing, and overhead allocations. Research and development expenses were $3.9 million and $11.9 million, respectively, for the three and nine months ended June 30, 2004, compared to $3.8 million and $11.8 million, respectively, for the three and
nine months ended June 30, 2003.



We expect to continue to allocate substantial
resources to product and technological development. Research and development expenses will remain consistent. We believe our process for developing software is essentially completed concurrently with the establishment of technological feasibility
and therefore we do not capitalize software development costs.



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##### Table of Contents

Selling and Marketing. Selling and marketing expenses consist primarily of salary and commission expenses for our
sales force and related travel expenses, advertising and promotional expenses, product marketing, customer service and support costs. Selling and marketing expenses were $5.2 million and $15.2 million, respectively, for the three and nine months
ended June 30, 2004, compared to $4.9 million and $15.3 million, respectively, for the three and nine months ended June 30, 2003. The increase for the three months ended June 30, 2004, compared to the three months ended June 30, 2003 was primarily
due to increased headcount and employee related expenses partially off-set by decreased commission expense as a result of changes to sales compensation plans. Selling and marketing expenses for the nine months ended June 30, 2004 were consistent
with expenses for the nine months ended June 30, 2003. We expect that selling and marketing expenses will remain at current levels.



General and Administrative. General and administrative expenses consist primarily of employee related expenses, legal and accounting fees as well as insurance
costs. General and administrative expenses for the three and nine months ended June 30, 2004 were $1.2 million and $3.6 million, respectively, compared to $1.0 million and $3.5 million, respectively, for the three and nine months ended June 30,
2003. The increase in general and administrative expenses for the three and nine months ended June 30, 2004 compared the same periods in the prior year was primarily due to increased employee related expenses and increased professional fees.



We anticipate that general and administrative expenses for fiscal 2005 may
increase as a result of the ongoing legal expenses relating to the SEC investigation and private securities litigation resulting from the Internal Accounting Review and the restatements of our financial statements, as well as increased expenses
related to implementation of Section 404 of the Sarbanes-Oxley Act, which requires our management to assess the effectiveness of our internal controls over financial reporting.



Amortization of Other Intangible Assets. For the three and nine months ended June 30, 2004, amortization of other intangible assets
represents the amortization of intangible assets with identifiable lives related to our acquisitions of JadeSail and Cayman. For comparative purposes, these items have been reclassified in the June 30, 2003 presentation for consistency and are now
presented as a category in cost of revenues excluding the portion related to sales and marketing which remained in operating expenses. For the three and nine months ended June 30, 2003, amortization of other intangible assets represents the
amortization of intangible assets with identifiable lives related to our acquisition of Cayman (See Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q).



Restructuring Costs. There were no restructuring costs for the three and nine months
ended June 30, 2004. For the three and nine months ended June 30, 2003, restructuring costs primarily consisted of employee severance benefits related to a reduction in workforce, and facility closure costs related to the closure of a sales office
in Hong Kong. (See Note 9 of Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q).



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##### Table of Contents

Risk Factors



The following risk factors discussed below should be considered carefully in evaluating our business because such factors may have a significant impact on our business,
operating results and financial condition. As a result of these risk factors and other risks discussed elsewhere in this Form 10-Q, and the risks discussed in our other filings with the United States Securities and Exchange Commission, our actual
results could differ materially from those projected in any forward-looking statements. You should carefully consider all these risks and other information in this report before investing in Netopia. The fact that certain risks are endemic to our
industry does not lessen the significance of the risk.



We have a
history of losses and negative cash flow. We may incur losses and negative cash flow in the future, which could significantly harm our business.



During the quarter ended June 30, 2004, we incurred a loss of $2.3 million and used $4.6 million of cash for operating activities. We incurred losses from continuing
operations of $8.3 million and $31.9 million for the fiscal years ended September 30, 2003 and 2002, respectively, and used $2.8 million and $10.7 million and $2.1 million of cash during the fiscal years ended September 30, 2003 and 2002,
respectively. Our cash and cash equivalents totaled $23.5 million at June 30, 2004. We may not be able to reach, sustain or increase profitability or generate cash on a quarterly or annual basis, which could significantly harm our business.



We may find it difficult to raise needed capital in the future, which could
delay or prevent introduction of new products or services, require us to reduce our business operations or otherwise significantly harm our business.



We must continue to enhance and expand our product and service offerings in order to maintain our competitive position and to increase our market share. As a result, and
due to any future net losses and use of cash, the continuing operations of our business may require capital infusions. Whether or when we can achieve cash flow levels sufficient to support our operations cannot be accurately predicted. Unless such
cash flow levels are achieved, we may require additional borrowings or the sale of debt or equity securities, sale of non-strategic assets, or some combination thereof, to provide funding for our operations. We believe we have adequate cash, cash
equivalents and borrowing capacity are adequate to meet our anticipated capital needs for the next twelve months. However, if we are unable to obtain additional funds to finance our operations when needed, our financial condition and operating
results would be materially and adversely affected and we would not be able to operate our business.



If we are unable to resolve pending private securities litigation and the SEC investigation related to and arising out of the restatement of our consolidated financial statements in a timely and economic manner,
our business could be significantly harmed.



We currently are named as a
defendant in a consolidated private securities action brought as a purported class action. In addition, there are purported derivative actions pending in state and federal court in California. We also are the subject of a formal order of
investigation by the Securities and Exchange Commission to determine whether the federal securities laws have been violated. Responding to the formal order of investigation will require significant attention and resources of management. If the SEC
elects to pursue an enforcement action, the defense could be costly and require additional management resources. If we were unsuccessful in defending against this or other investigations or proceedings, we could face civil or criminal penalties that
would seriously harm our business and results of operations. Defending against the securities class action and derivative actions also will likely require significant attention and resources of management and, regardless of the outcome, result in
significant legal expense. If our defenses ultimately are unsuccessful, or if we are unable to achieve a favorable settlement, we could we liable for large damage awards that could seriously harm our business and results of operations. While we have
provided notice of the securities class action and derivative actions to our directors and officers liability insurance carriers, the insurance carriers have not agreed to pay for our legal expenses incurred in defending against these actions or
agreed that they are responsible to pay



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any damages that ultimately could be awarded to the plaintiffs. Furthermore, we have only a limited amount of insurance, and even if our insurers agree to
make payments under the policies, the damage awards or settlements may be greater than the amount of insurance, and we would in all cases be liable for any amounts in excess of our insurance policy limits.



Substantial sales of our broadband equipment will not occur unless telecommunications
carriers and service providers continue to expand their deployments of DSL and other broadband services, and this could reduce our revenues and significantly harm our business.



The success of our broadband equipment depends upon the extent to which telecommunications carriers and service providers continue to expand
their deployments of DSL and other broadband services. Factors that have impacted such deployments include:



| |  |  | Lengthy approval processes followed by carriers and service providers, including laboratory tests, technical trials, marketing trials, initial commercial deployment and full
commercial deployment;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The continued improvement of business models for DSL and other broadband services, including the capability to market, sell, install and maintain DSL and other broadband services;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Lack of compatibility of DSL equipment that is supplied by different manufacturers;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | Rapidly changing industry standards for DSL and other broadband technologies; and
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Government regulation.
| | - |  | ----------------------



We offer to carriers and service providers the opportunity to bundle basic DSL connectivity with value-added features that enable the provider to bundle differentiated features and services that we believe can justify
higher recurring revenues from end users. These features and services include dial backup, VPNs, remote management and configuration, a parental controls service, and hosting of eSites and eStores. We can offer no assurance that our strategy of
enabling bundled service offerings will be widely accepted. If telecommunications carriers and service providers do not continue to expand their deployments of DSL and other broadband services, our revenues could decline and our business could be
significantly harmed.



We expect our revenues to become increasingly
dependent on our ability to sell our broadband equipment to ILECs, and we may incur losses if we cannot successfully market and sell our products through ILEC channels.



ILECs have been aggressively marketing DSL services principally focusing on residential services. Prior to our acquisition of Cayman, we had
not sold meaningful quantities of our Broadband equipment to ILECs in the United States. As a result of our acquisition of Cayman, we expanded our customer base to include two ILEC customers in the United States, SBC and BellSouth, to which we
previously had not sold our Broadband equipment. We have committed resources that are working to expand our sales in the ILEC channel both domestically and internationally. There continue to be barriers associated with such sales including, but not
limited to, lengthy product evaluation cycles, the ability to dislodge competitors whose products are currently being utilized, long-term product deployment cycles and intense price pressures. ILECs currently obtain equipment from our competitors,
such as 2Wire, Inc., Siemens Aktiengesellschaft (through its Siemens Subscriber Networks, Inc. subsidiary, formerly known as Efficient Networks), Thomson Corporation, Westell Technologies, Inc. and ZyXEL Communications Co., which have proven to be
strong competitors. There is no guarantee we will be successful in expanding our presence in the ILEC market. If we fail to penetrate further the ILEC market for our products and services, our business may be materially and adversely affected.



The loss of, or decline in, purchases by one or more of our key customers
would result in a significant decline in our revenues and harm business.



We rely on a small number of customers for a large portion of our revenues. For both the three months ended June 30, 2004 and the fiscal year ended September 30, 2003, there were seven and four customers, respectively, that each
individually represented at least 5% of our revenues and in the



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aggregate, accounted for 67% and 48%, respectively, of our total revenues. Our revenues will decline and our business may be significantly harmed if one or
more of our significant customers stop buying our products, or reduce or delay purchases of our products.



Substantial portions of our revenues are derived from sales to international customers, and currency fluctuations can adversely impact our operations.



A substantial portion of our revenues is derived from sales to international customers,
mainly in Europe. For the three months ended June 30, 2004 and the fiscal year ended September 30, 2003, our international sales represented 40% and 32%, respectively, of our total revenues. We expect sales to international customers to continue to
comprise a significant portion of our revenues. Sales of broadband equipment products to many of our European customers are denominated in Euros. For our international sales that continue to be denominated in United States dollars, fluctuations in
currency exchange rates could cause our products and services to become relatively more expensive to our foreign customers, who could result in decreased sales of our products and services. In addition, changes in the value of the Euro relative to
the United States dollar could adversely affect our operating results to the extent we do not adequately hedge sales denominated in Euros.



Additional risks associated with international operations could adversely affect our sales and operating results in Europe.



Our international operations are subject to a number of difficulties and special costs,
including, but not limited to:



| |  |  | Costs of customizing products for foreign countries;
| | - |  | ----------------------------------------------------



| |  |  | Laws and business practices favoring local competitors;
| | - |  | -------------------------------------------------------



| |  |  | Dependence on local vendors;
| | - |  | ----------------------------



| |  |  | Uncertain regulation of electronic commerce;
| | - |  | --------------------------------------------



| |  |  | Compliance with multiple, conflicting and changing governmental laws and regulations;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | Longer sales cycles;
| | - |  | --------------------



| |  |  | Greater difficulty in collecting accounts receivable;
| | - |  | -----------------------------------------------------



| |  |  | Import and export restrictions and tariffs;
| | - |  | -------------------------------------------



| |  |  | Difficulties staffing and managing foreign operations;
| | - |  | ------------------------------------------------------



| |  |  | Multiple conflicting tax laws and regulations; and
| | - |  | --------------------------------------------------



| |  |  | Political and economic instability.
| | - |  | -----------------------------------



In addition, if we establish more significant operations overseas, we may incur additional costs that would be difficult to reduce quickly because of employee-related
laws and practices in those countries.



Because the markets for our products
and services are intensely competitive and some of our competitors are larger, better established and have more cash resources, we may not be able to compete successfully against current and future competitors.



We sell products and services in markets that are highly competitive. We expect competition
to intensify as current competitors expand their product and service offerings and new competitors enter the market. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which
could seriously harm our business. Competitors vary in size, scope and breadth of the products and services offered.



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In the market for broadband equipment, we primarily compete with 2Wire, Siemens (through its Siemens Subscriber Networks,
Inc. subsidiary, formerly known as Efficient Networks), Thomson, Westell and ZyXEL.



In the market for our broadband software and services products, we primarily compete with Altiris, Inc., Computer Associates International, Inc., CrossTec Corporation, Expertcity, Inc., LANDesk Software, Inc., Microsoft Corporation and
Symantec Corporation. We anticipate intense competition from some of these companies because some of these competitors provide their products to consumers at no cost.



Many of our current and potential competitors in all product areas have longer operating histories, significantly greater financial,
technical, marketing and other resources, significantly greater name recognition and a larger base of customers than we do. In addition, many of our competitors have well-established relationships with our current and potential customers and have
extensive knowledge of these industries. In the past, we have lost potential customers to competitors in all product areas for various reasons, including lower prices and other incentives not matched by us. In addition, current and potential
competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products and services to address customer needs. Accordingly, new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of industry consolidation.



Our quarterly operating results are likely to fluctuate because of many factors and may cause our stock price to fluctuate.



Our revenues and operating results have varied in the past and are likely to vary in the
future from quarter to quarter. For example, during the past eight quarters ending June 30, 2004, our revenues have ranged from $17.1 million to $28.3 million, and our net results have ranged from $1.2 million of income to a loss of $46.6 million.
As a result, we believe that period-to-period comparisons of our operating results are not necessarily meaningful. Investors should not rely on the results of any one quarter or series of quarters as an indication of our future performance.



During the quarters ended June 30, 2004 and March 31, 2004, our operating
results were below the expectations of securities analysts. It also is likely that in some future quarter, quarters or year, our operating results again will be below the expectations of securities analysts or investors. When our operating results
are below such expectations, the market price of our common stock may decline significantly. In addition to the uncertainties and risks described elsewhere under this Risk Factors heading, variations in our operating results will likely
be caused by factors related to the operation of our business, including, but not limited to:



| |  |  | Variations in the timing and size of orders for our broadband equipment products;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Increased price competition for our broadband equipment products;
| | - |  | -----------------------------------------------------------------



| |  |  | Our ability to license, and the timing of licenses, of our broadband software and services products;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | The mix of products and services and the gross margins associated with such products and services, including the impact of our increased sales of lower margin broadband equipment as
a percentage of our total revenues and increased sales of lower margin ADSL products within our family of Broadband equipment;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The price and availability of components for our broadband equipment; and
| | - |  | -------------------------------------------------------------------------



| |  |  | The timing and size of expenses, including operating expenses and expenses of developing new products and product enhancements.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



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Other technologies for the broadband gateway market compete with DSL services.



DSL services compete with a variety of different broadband services, including cable,
satellite and other wireless technologies. Many of these technologies compete effectively with DSL services. If any technology competing with DSL technology is more reliable, faster, less expensive, reaches more customers or has other advantages
over DSL technology, then the demand for our DSL products and services and our revenues and gross margins will decrease. There is no guarantee we will be able to develop and introduce products for these competing technologies.



We purchase the semiconductor chips for our broadband Internet products from a limited
number of suppliers, and the inability to obtain in a timely manner a sufficient quantity of chips at an economic price would adversely affect our business.



All of our broadband equipment products rely on special semiconductor chips that we purchase from fewer than five suppliers. We do not have
volume purchase contracts with any of our suppliers and they could cease selling to us at any time. In addition, our suppliers change their selling prices frequently in response to market trends, including increased demand industry-wide. Because we
generally have been unable to pass component price increases along to our customers, our gross margins and operating results have been harmed as a result of component price increases. If we are unable to obtain a sufficient quantity of these
semiconductor chips in a timely manner for any reason, sales of our broadband equipment products could be delayed or halted. Further, we could also be forced to redesign our broadband equipment products and qualify new suppliers of semiconductor
chip sets. The resulting stoppage or delay in selling our products and the expense of redesigning our products would adversely affect our business.



If we were unable to obtain components and manufacturing services for our Broadband equipment from independent contractors and specialized suppliers, our business
would be harmed.



We do not manufacture any of the components used in our
products and perform only limited assembly on some products. All of our broadband equipment relies on components that are supplied by independent contractors and specialized suppliers. Furthermore, substantially all of our roadband equipment
includes printed circuit boards that are manufactured by fewer than five contract manufacturers that assemble and package our products. We do not have guaranteed supply arrangements with these third parties and they could cease selling components to
us at any time. Moreover, the ability of independent contractors and specialized suppliers to provide us with sufficient components for our broadband equipment also depends on our ability to accurately forecast our future requirements. If we are
unable to obtain a sufficient quantity of components from independent contractors or specialized suppliers in a timely manner for any reason, sales of our broadband equipment could be delayed or halted. Similarly, if supplies of circuit boards or
products from our contract manufacturers are interrupted for any reason, we will incur significant losses until we arrange for alternative sources. In addition, we may be required to pay premiums for components purchased from other vendors should
our regular independent contractors and specialized suppliers be unable to timely provide us with sufficient quantity of components. To the extent we pay any premiums, our gross margins and operating results would be harmed. Further, we could also
be forced to redesign our broadband equipment and qualify new suppliers of components. The resulting stoppage or delay in selling our products and the expense of redesigning our broadband equipment would seriously harm our reputation and business.



Failure to develop, introduce and market new and enhanced products
and services in a timely manner could harm our competitive position and operating results.



We compete in markets characterized by continuing technological advancement, changes in customer requirements and evolving industry standards. To compete successfully, we must design, develop, manufacture and sell new
or enhanced products and services that provide increasingly higher levels of performance, reliability, compatibility, and cost savings for our customers. We will need to continue to integrate our DSL modem and router technology with the
architectures of leading central office equipment providers in order to enhance the reliability, ease-of-use and management functions of our DSL products.



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Our software platform known as Netopia Broadband Server (NBBS) enables network operations centers of broadband service
providers the ability to remotely manage, support, and troubleshoot installed broadband gateways, thereby providing the potential for reducing support costs. We believe that NBBS can assist us in differentiating our products and services from those
of our competitors. However, NBBS and the underlying technology are relatively new, and we cannot provide any assurance that, when deployed in mass scale, NBBS will perform as expected, there are no hidden bugs or defects, or it will be widely
adopted by the customers to whom we are marketing the platform.



We may not be
able to successfully develop, introduce, enhance or market these or other products and services necessary to our future success. In addition, any delay in developing, introducing or marketing these or other products would seriously harm our
business. Many of our broadband equipment products and services are relatively new. You should consider our prospects in light of the difficulties we may encounter because these products are at an early stage of development in a rapidly evolving and
intensely competitive market. For example, we may not correctly anticipate market requirements, or introduce rapidly new products that meet such requirements for performance, price, features and compatibility with other DSL equipment. Failure to
continue to develop and market competitive products would harm our competitive position and operating results.



Our revenues will not grow and we may incur greater losses if we cannot successfully sell our broadband software and services products. We derive a substantial portion of the recurring revenues from our broadband
software and services products from a small number of large customers.



The majority of our broadband software and services revenues are derived from the sale of software products for corporate help desks, including Timbuktu and eCare. For the three months ended June 30, 2004 and the fiscal year ended September
30, 2003, revenues from these help desk applications were 70% and 62%, respectively, of total revenues for our broadband software and services products. We anticipate that the market for Timbuktu will grow more slowly than the market for our other
broadband software products and services. We also have not derived significant revenues from the Netopia Broadband Server software platform. In addition, we rely on a small number of licensees of our broadband software and services to promote the
use of our broadband software and services for building web sites and stores. As a result, we derive the majority of the recurring revenues from our broadband software and services products from fewer than five customers. The extent and nature of
the promotions by licensees of our broadband software and services are outside of our control. If licensees of our eSite and eStore software do not successfully promote web sites and stores to their customers, we will not generate continued
recurring revenues. If these customers were to choose a competitive platform, this could lead to reduced revenues and adversely impact our results.



If hosting services for our broadband software and services perform poorly, our revenue may decline and we could be sued.



We depend on our servers, networking hardware and software infrastructure, and third-party
service and maintenance of these items to provide reliable, high-performance hosting for eSite and eStore customers and subscribers to our parental controls service. In addition, our servers are located at third-party facilities. Failure or poor
performance by third parties with which we contract for maintenance services could also lead to interruption or deterioration of our parental controls, eSite and eStore hosting services. Additionally, a slowdown or failure of our systems for any
reason could also lead to interruption or deterioration of our parental controls, eSite and eStore hosting services. In such a circumstance, our hosting and subscription revenues may decline. In addition, if our parental controls, eSite and eStore
hosting services are interrupted, perform poorly, or are unreliable, we are at risk of litigation from our customers, the outcome of which could harm our business.



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We may continue to experience declining gross margins due to price competition and an increase in sales of lower
margin broadband equipment as a percentage of our total revenue.



We
expect that sales of our broadband equipment may account for a larger percentage of our total revenues in future periods. Because our broadband equipment products are sold at lower gross margins than our broadband software and services products, and
sales volumes of our lower margin ADSL products are increasing, our overall gross margins will likely decrease. Further, we expect that the market for broadband equipment will remain highly competitive and as a result, we will be continue to lower
the prices we charge for our broadband equipment. If the average selling price of our broadband equipment continues to decline faster than our ability to realize lower manufacturing and product costs, our gross margins related to such products, as
well as our overall gross margins, are likely to decline.



Failure to
attract or retain key personnel could harm our business.



Our future
performance depends on the continued service of our senior management, product development and sales personnel. The loss of the services of one or more of our key personnel could seriously harm our business. Competition for qualified personnel in
our industry and geographic location is intense. Although we believe our personnel turnover rate is consistent with industry norms, our future success depends on our continuing ability to attract, hire, train and retain highly skilled managerial,
technical, sales, marketing and customer support personnel. In addition, new hires frequently require extensive training before they achieve desired levels of productivity.



Our intellectual property may not be adequately protected, and our products may infringe upon the intellectual property rights of third
parties, which may adversely impact our competitive position and require us to engage in costly litigation.



We depend on our ability to develop and maintain the proprietary aspects of our technology. To protect our proprietary technology, we rely primarily on a combination of
contractual provisions, confidentiality procedures, trade secrets, and patent, copyright and trademark law. We presently have one United States patent issued that relates to our Timbuktu and eCare software. The term of this patent is through August
2010. We also have filed a provisional patent application relating to the design of our Wi-Fi DSL gateways. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use
information that we regard as proprietary. Policing unauthorized use of our products is difficult, and there is no guarantee that the safeguards that we employ will protect our intellectual property and other valuable competitive information.



There has been a substantial amount of litigation in the software and Internet
industries regarding intellectual property rights. Although we have not been party to any such litigation, in the future third parties may claim that our current or potential future products or we infringe their intellectual property. The evaluation
and defense of any such claims, with or without merit, could be time-consuming and expensive. Furthermore, such claims could cause product shipment delays or require us to enter into royalty or licensing agreements on financially unattractive terms,
which could seriously harm our business.



If we are unable to license
necessary software, firmware and hardware designs from third parties, our business could be harmed.



We rely upon certain software, firmware and hardware designs that we license from third parties, including firmware that is integrated with our internally developed firmware and used in our products. We cannot be
certain that these third-party licenses will continue to be available to us on commercially reasonable terms. The loss of, or inability to maintain, such licenses could result in product shipment delays until equivalent firmware is developed or
licensed, and integrated into our products, which would seriously harm our business.



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Our products are complex and may contain undetected or unresolved defects.



Our products are complex and may contain undetected or unresolved defects when first
introduced or as new versions are released. Although we historically have not experienced material problems with product defects, if our products do contain undetected or unresolved defects, we may lose market share, experience delays in or losses
of market acceptance or be required to issue a product recall. Similarly, although we have not experienced material warranty claims, if warranty claims exceed our reserves for such claims, our business would be seriously harmed. In addition, we
would be at risk of product liability litigation because of defects in our products. Although we attempt to limit our liability to end users through disclaimers of special, consequential and indirect damages and similar provisions, we cannot assure
you that such limitations of liability will be legally enforceable.



Substantial sales of our common stock by our large stockholders could cause our stock price to fall.



A small number of stockholders hold a large portion of our common stock. One of our directors owns approximately 3.7% of our common stock outstanding at January 28, 2005.
To the extent any of our large stockholders decides to sell substantial amounts of our common stock in the public market over a short period of time, based on the historic trading volumes, we expect the market price of our common stock could fall.



Our industry may become subject to changes in regulations, which
could harm our business.



Our industry and industries on which our
business depends may be affected by changes in regulations. For example, we depend on telecommunications service providers for sales of our broadband equipment, and companies in the telecommunications industry must comply with numerous regulations.
If our industry or industries on which we depend become subject to regulatory changes that increase the cost of doing business or doing business with us, our revenues could decline and our business could be harmed. For example, if a regulatory
agency imposed restrictions on DSL service that were not also imposed on other forms of high-speed Internet access, our business could be harmed.



Business interruptions that prevent our ability to deliver products and services to our customers could adversely affect our business.



Our operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure, terrorist attacks, labor disputes by transportation providers, and other events beyond our control. In particular, our headquarters are located near earthquake fault lines in the San Francisco Bay area and may be
susceptible to the risk of earthquakes. If there is an earthquake in the region, our business could be seriously harmed. We do not have a detailed disaster recovery plan. In addition, our business interruption insurance may not be sufficient to
compensate us fully for losses that may occur and any losses or damages incurred by us in the event we are unable to deliver products and services to our customers could have a material adverse effect on our business.



Our stock price may be volatile, which may result in substantial losses for our
stockholders.



The market price of our common stock may fluctuate
significantly in response to many factors, some of which are beyond our control, including the following:



| |  |  | Variations in our quarterly operating results, including shortfalls in revenues or earnings from securities analysts expectations;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in securities analysts estimates of our financial performance;
| | - |  | -----------------------------------------------------------------------



| |  |  | Changes in market valuations and volatility generally of securities of other companies in our industry;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | Announcements by us or our competitors of technological innovations, new products or enhancements, significant contracts, acquisitions, strategic partnerships, joint ventures or
capital commitments; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | General conditions in the broadband communications industry, in particular the DSL market.
| | - |  | ------------------------------------------------------------------------------------------



In recent years the stock market in general, and the market for shares of high technology stocks in particular, have experienced extreme
price fluctuations, which often have been unrelated to the operating performance of affected companies. There can be no assurance that the market price of our common stock will not experience significant fluctuations in the future as it has in the
past, including fluctuations that are unrelated to our performance. In the past, securities class action litigation has often been brought against a company following periods of volatility in market price of its securities. We have recently
experienced significant volatility in the price of our stock. We currently are and may in the future be the target of securities litigation. Securities litigation could result in substantial costs and divert managements attention and
resources, which could seriously harm our business.



A third party may have
difficulty acquiring us, even if doing so would be beneficial to our stockholders.



Provisions of our Amended and Restated Certificate of Incorporation, our Bylaws and Delaware law could make it difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.



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PART I  FINANCIAL INFORMATION



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Cash and Cash Equivalents



Our exposure
to market risks for changes in interest rates primarily relates to our investment portfolio. Our investments are made in accordance with an investment policy approved by our Board of Directors, which aims at minimizing credit risk through the
diversification of our investments. Maturities of our investments are typically 90-days or less. The investments are classified as held-to-maturity and properly carried on our condensed consolidated balance sheets at its original purchase price. Our
investment instruments are subject to changes in the interest rate and credit rating risk. Additionally, the value of our investments may be impaired temporarily or permanently. Due in part to these risk factors, our investment income may decline
and we may suffer losses in principal. We do not use derivatives to reduce or eliminate our exposure to changes in interest rates or credit ratings.



The table below presents the market value and related weighted-average interest rates for our investment portfolio at June 30, 2004 and 2003. All investments mature in
90-days or less.



|                                                       |  |                |        |                 |                |                     |  |      |           |  |                 |       |                       |   |       |  |     |  
|------------------------------------------------------ |  | -------------- | ------ | --------------- | -------------- | ------------------- |  | ---- | --------- |  | --------------- | ----- | --------------------- | - | ----- |  | --- | -
|                                                       |  | June 30, 2004  |        |                 | June 30, 2003  |                    
|Principal (notional) amounts in United
States dollars: |  | Costbasis      |        | Fairmarketvalue |                | Averageinterestrate |  |      | Costbasis |  | Fairmarketvalue |       | Average interest rate |  
|                                                       |  | (in thousands) |        |                 | (in thousands) |                    
|Cash equivalents                                       |  | $              | 16,607 |                 | $              | 16,607              |  | 0.92 | %         |  | $               | 9,747 |                       | $ | 9,747 |  | 1.3 | %



Other Interest Rate Risks



Our market interest rate risk for borrowings under our credit facility,
from which we had no borrowings at June 30, 2004, which relates primarily to the rate charged by Silicon Valley Bank in conjunction credit facility agreement. The credit facility bears interest at a rate equal to the prime rate (the rate announced
by Silicon Valley Bank as its prime rate) as long as no default or event of default has occurred and is continuing, and as long as we maintain profitability as of the end of each fiscal quarter. To the extent there is a default or an
event of default has occurred and is continuing or we cannot maintain profitability, the interest rate on the credit facility would change to the prime rate plus 0.75% per annum. To the extent we borrow interest rates increase, which would result in
increased expense.



Foreign Currency



Our exposure to foreign exchange risk relates primarily to sales and corresponding
receivables made to international customers denominated in Euros and employee-related expenses for employees based in European Union countries. We are subject to risks typical of an international business including, but not limited to, differing
economic conditions and tax structures, other regulations and restrictions and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors. To minimize the effects of
potential short-term fluctuations on our operating result stemming from our exposure to foreign currency changes, we enter into currency exchange forward contracts. These contracts guarantee a predetermined exchange rate at the time the contract is
purchased. In June 2004, we entered into forward contracts to hedge forecasted revenues for June, July, August and September 2004 denominated in Euros. All currency exchange contracts have a maturity of less than one year.



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The table below presents the carrying value, in United States dollars, of accounts receivables denominated in Euros at
June 30, 2004 and 2003. The accounts receivable at June 30, 2004 are valued at the United States/Euro exchange rate as of June 30, 2004 and the accounts receivable at June 30, 2003 are valued at the United States/Euro exchange rate as of June 30,
2003. The carrying value approximates fair value at June 30, 2004 and 2003.



|                                           |  |                |       |                |        |                |   |               |  |       
|------------------------------------------ |  | -------------- | ----- | -------------- | ------ | -------------- | - | ------------- |  | ------
|                                           |  | June 30, 2004  |       | June 30, 2003 
|Carrying amounts in United States dollars: |  | Carryingamount |       | Exchangerate   |        | CarryingAmount |   | Exchange rate
|                                           |  | (in thousands) |       | (in thousands)
|Accounts receivable denominated in Euros   |  | $              | 2,437 |                | 1.2085 |                | $ | 1,820         |  | 1.1677



The table below presents the carrying
value of our currency exchange forward contracts, in United States dollars, at June 30, 2004 and 2003. The carrying value approximates fair value at June 30, 2004 and 2003.



|                                       |  |                 |        |                |             |        |                |         |                 |   |             |  |                 |  |       
|-------------------------------------- |  | --------------- | ------ | -------------- | ----------- | ------ | -------------- | ------- | --------------- | - | ----------- |  | --------------- |  | ------
|                                       |  | June 30, 2004   |        | June 30, 2003 
|Carrying amounts In Euros:             |  | Carrying amount |        |                | ForwardRate |        | Settlementdate |         | Carrying Amount |   | ForwardRate |  | Settlement Date
|                                       |  | (in thousands)  |        | (in thousands)
|Currency exchange forward contract # 1 |  | $               | (290   | )              |             | 1.2006 |                | Jul-04  |                 | $ | 473         |  | 1.1425          |  | Jul-03
|Currency exchange forward contract # 2 |  | $               | 1,039  |                |             | 1.1979 |                | Jul-04  |                 |   |             |  |                 |  |       
|Currency exchange forward contract # 3 |  | $               | (1,039 | )              |             | 1.1979 |                | Jul-04  |                 |   |             |  |                 |  |       
|Currency exchange forward contract # 4 |  | $               | 790    |                |             | 1.2050 |                | Jul-04  |                 |   |             |  |                 |  |       
|Currency exchange forward contract # 5 |  | $               | (224   | )              |             | 1.1995 |                | Aug-04  |                 |   |             |  |                 |  |       
|Cash flow hedge contract # 6           |  | $               | 1,674  |                |             | 1.1960 |                | Aug-04  |                 |   |             |  |                 |  |       
|Cash flow hedge contract # 7           |  | $               | (224   | )              |             | 1.1985 |                | Sept-04 |                 |   |             |  |                 |  |       
|Cash flow hedge contract # 8           |  | $               | 1,957  |                |             | 1.2058 |                | Sept-04 |                 |   |             |  |                 |  |       



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PART I  FINANCIAL INFORMATION



ITEM 4. CONTROLS AND PROCEDURES



Evaluation of
disclosure controls and procedures



As of the end of the period covered by
this report, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and Interim Chief Financial Officer, of the effectiveness of the design and operation
of our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon this evaluation, our President and Chief Executive Officer and our Interim Chief Financial Officer concluded that our
disclosure controls and procedures were adequate to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the
United States Securities and Exchange Commission rules and forms.



Changes
in internal controls



During the three and nine months ended June 30,
2004, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



As described in Note 13 of Notes to Consolidated Financial Statement, as a result of the
Internal Accounting Review, we are restating our financial statements for the fiscal years ended September 30, 2002 and 2003, and our interim financial statements for the fiscal quarters ended December 31, 2003 and March 31, 2004. As a result of the
Internal Accounting Review commenced in July 2004, the filing of both this Report on Form 10-Q for the third fiscal quarter ended June 30, 2004 and the 2004 10-K have been delayed beyond the designated filing deadlines.



In response to the matters discovered in connection with the Internal Accounting Review, we
have taken steps to strengthen control processes and procedures to identify, rectify and prevent the recurrence of the circumstances that resulted in our determination to restate prior period financial statements. In addition to the changes in
internal controls listed below, we intend to correct the identified weaknesses in our internal controls and procedures that led to the restatements by taking the following steps, among others:



| |  |  | Making changes in our personnel, including the appointment of a new senior sales executive and a new Interim Chief Financial Officer;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Continuing to improve the quality and experience of in-house finance personnel with extensive software revenue recognition experience;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Conducting and continuing to develop internal training programs for affected employees on applicable policies and procedures and sending finance personnel to external training and
continuing education programs;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Continuing to improve the operational procedures for software transactions to ensure that proper documentation has been prepared and approved prior to recording revenue in
accordance with the principles of Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We believe changes to our system of internal controls and our disclosure controls and procedures will be adequate to provide reasonable assurance that the objectives of
these controls will be met. We intend to review and evaluate the design and effectiveness of our disclosure controls and procedures on an



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ongoing basis and to improve our controls and procedures over time and to correct any deficiencies that we may discover in the future. Our goal is to ensure
that our senior management has timely access to all material financial and non-financial information concerning our business. While we believe the present design of our disclosure controls and procedures is effective to achieve our goal, future
events affecting our business may cause us to modify our disclosure controls and procedures. Furthermore, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues,
if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.



We are in the process of implementing the requirements of Section 404 of the Sarbanes-Oxley
Act of 2002 that requires our management to assess the effectiveness of our internal controls over financial reporting and include an assertion in our annual report as to the effectiveness of our controls. Subsequently, our independent auditors,
Burr Pilger & Mayer LLP, will be required to attest to whether our assessment of our internal controls over financial reporting is fairly stated in all material respects and separately report on whether it believes we maintained, in all material
respects, effective internal controls over financial reporting as of September 30, 2005. We are in the process of performing the system and process documentation, evaluation and testing required for management to make this assessment and for the
auditors to provide its attestation report. We have not completed this process or its assessment, and this process will require significant amounts of management time and resources. In the course of evaluation and testing, management may identify
deficiencies that will need to be addressed and remediated.



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PART II  OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



We are named as a
defendant in an action pending in the United States Bankruptcy Court for the Northern District of California entitled E. Lynn Schoenmann, trustee of NorthPoint Communications, Inc. v. Netopia. In this action commenced on January 11, 2003, the
trustee of the bankruptcy estate of NorthPoint Communications, Inc. (NorthPoint) is seeking to recover approximately $1.2 million that NorthPoint paid to us within the 90 day preference period before NorthPoint filed for bankruptcy in
January 2001. NorthPoints trustee is claiming that NorthPoint was insolvent at the time it made these payments, and that therefore the payments are recoverable preferences within the meaning of the Bankruptcy Code. We believe that we have
defenses to the claims asserted by NorthPoints trustee, and we intend to continue to defend ourselves vigorously. We do not believe that the outcome of this lawsuit is likely to harm our business seriously.



In August 2004, the first of four purported class action complaints, Valentin Serafimov,
on behalf of himself and all others similarly situated, v. Netopia, Inc., Alan B. Lefkof and William D. Baker, was filed in the United States District Court for the Northern District of California. The complaint alleged violations of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaint alleged that during the purported class period, November 6, 2003 and July 6, 2004, we made materially false, misleading and incomplete statements and issued false and
misleading reports regarding our earnings, product costs, and sales to foreign customers. The other three complaints that subsequently were filed made additional related claims based on the same announcements and allegations of misstatements. As
provided in the Private Securities Litigation Reform Act of 1995, the plaintiffs in these actions filed motions to consolidate and to appoint lead plaintiff and lead plaintiff counsel. On December 3, 2004, the court issued an order consolidating the
cases under the name In re Netopia, Inc. Securities Litigation, and appointing a lead plaintiff and plaintiffs counsel. The lead plaintiff has not filed its consolidated amended complaint. We believe that we have strong defenses to the
claims asserted in the complaints as initially filed. We intend to defend the case vigorously.



In August 2004, the first of four purported derivative actions, Freeport Partners, LLC, Derivatively on Behalf of Nominal Defendant Netopia, Inc., v. Alan B. Lefkof, William D. Baker, Reese M. Jones, Harold S.
Wills, Robert Lee and Netopia, Inc., was filed in the United States District Court for the Northern District of California. Two purported derivative actions are pending in the United States District Court for the Northern District of California,
and two related purported derivative actions are pending in the Superior Court of California for the County of Alameda. These actions make claims against our officers and directors arising out of the same announcements and alleged misstatements
described above in connection with the purported class actions. In November 2004, the derivative plaintiffs agreed to coordinate the four derivative actions. The parties have agreed to a stay of the federal derivative actions, which was ordered by
the court in January 2005. The state actions have been consolidated under the name In re Netopia, Inc. Derivative Litigation. The plaintiffs have not filed their consolidated amended complaint. We believe that we have strong defenses to the
claims asserted in the complaints as initially filed. We intend to defend the cases vigorously.



On October 29, 2004, we were advised by the Securities and Exchange Commission that an informal inquiry previously commenced by the Securities and Exchange Commission had become the subject of a formal order of
investigation. This investigation is to determine whether the federal securities laws have been violated. We cooperated fully with the informal inquiry, and we are cooperating fully with the formal investigation. Responding to the formal
investigation will likely continue to require significant attention and resources of management. If the Securities and Exchange Commission elects to pursue an enforcement action, the defense against this type of action could be costly and require
additional management resources. If we were unsuccessful in defending against this or other investigations or proceedings, we could face civil or criminal penalties that would seriously harm our business and results of operations.



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In January 2005, we were notified by the Occupational Health and Safety Administration (OSHA) that Netopia was named in
an administrative complaint filed by two former employees alleging violations of Section 806 of the Corporate and Criminal Fraud Accountability Act of 2002, 18 U.S.C. § 1514A, also known as the Sarbanes-Oxley Act. The former employees allege
the Company terminated them in retaliation for their participation in the Internal Accounting Review conducted by the audit committee. We filed a response to the complaint on January 21, 2005 with OSHA. (The Internal Accounting Review is described
above in greater detail in Item 1, Note 13 to Unaudited Condensed Consolidated Financial Statements.) The agency has not determined whether it will conduct an investigation into this matter. We believe that we have strong defenses and intend to
defend the complaint vigorously.



Defending against the securities class action
and derivative actions will likely require significant attention and resources of management and, regardless of the outcome, result in significant legal expense. If our defenses ultimately are unsuccessful, or if we are unable to achieve a favorable
settlement, we could be liable for large damage awards that could seriously harm our business and results of operation. While we have provided notice of the securities class action and derivative actions to our directors and officers liability
insurance carriers, the insurance carriers have not agreed to pay for our legal expenses incurred in defending against these actions or agreed that they are responsible to pay any damages that ultimately could be awarded to the plaintiffs.
Furthermore, we have only a limited amount of insurance, and even if our insurers agree to make payments under the policies, the damage awards or settlements may be greater than the amount of insurance, and we would in all cases be liable for any
amounts in excess of our insurance policy limits.



In addition to the lawsuits
described above, from time to time we are involved in other litigation or disputes that are incidental to the conduct of our business. We are not party to any such other incidental litigation or dispute that in our opinion is likely to seriously
harm our business.



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



|(a) | Exhibits
|--- | --------



|              |  |                                                                                                   
|------------- |  | --------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                       
|31.1          |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|              | 
|32.1          |  | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|              | 
|32.2          |  | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



|(b) | We filed the following report on Form 8-K during the three months ended June 30, 2004:
|--- | --------------------------------------------------------------------------------------



| |  |  | On April 19, 2004, the Company filed a Current Report on Form 8-K reporting Item 7  Financial Statements and Exhibits and Item 12  Results of Operations and Financial
Condition, providing our financial results for the second fiscal quarter ended March 31, 2004.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



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



|                       |  |               |  |                                                                                                       
|---------------------- |  | ------------- |  | ------------------------------------------------------------------------------------------------------
|Date: February 1, 2005 |  | NETOPIA, INC.
|                       |  | (Registrant) 
|                       |  |              
|                       |  | By:           |  | /s/ Alan B. Lefkof                                                                                    
|                       |  |               |  | Alan B. Lefkof                                                                                        
|                       |  |               |  | President and Chief Executive Officer                                                                 
|                       |  |              
|                       |  | By:           |  | /s/ Mark H. Perry                                                                                     
|                       |  |               |  | Mark H. Perry                                                                                         
|                       |  |               |  | Interim Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)



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