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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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

For the quarterly period ended June 30, 2006

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

Netopia, Inc.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|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)



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(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    ü            No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large
accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated
filer              Accelerated filer    ü            Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

Yes                    No    ü

As of August 7, 2006, there were 26,124,021 shares of the Registrants common stock outstanding.



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##### Table of Contents

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NETOPIA, INC.

Form 10-Q

Table of Contents



|                                                                                                  |  |                                                                                                                                   |  |     
|------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                  |  |                                                                                                                                   |  | Page
|PART I. FINANCIAL INFORMATION                                                                     |  |                                                                                                                                  
|                                                                                                  | 
|Item 1.     Condensed Consolidated Financial Statements                                           |  | 1                                                                                                                                
|                                                                                                  |  |                                                                                                                                  
|                                                                                                  |  | Condensed Consolidated Balance Sheets at June 30, 2006 and September 30, 2005                                                     |  | 1   
|                                                                                                  |  |                                                                                                                                  
|                                                                                                  |  | Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2006 and 2005                        |  | 2   
|                                                                                                  |  |                                                                                                                                  
|                                                                                                  |  | Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2006 and 2005                                  |  | 3   
|                                                                                                  |  |                                                                                                                                  
|                                                                                                  |  | Condensed Consolidated Statements of Stockholders Equity and Comprehensive Loss for the nine months ended June 30, 2006 and 2005 |  | 4   
|                                                                                                  |  |                                                                                                                                  
|                                                                                                  |  | Notes to Condensed Consolidated Financial Statements                                                                              |  | 5   
|                                                                                                  | 
|Item 2.     Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 17                                                                                                                               
|                                                                                                  | 
|Item 3.     Quantitative and Qualitative Disclosures About Market Risk                            |  | 36                                                                                                                               
|                                                                                                  | 
|Item 4.     Controls and Procedures                                                               |  | 36                                                                                                                               
|                                                                                                  | 
|PART II. OTHER INFORMATION                                                                        |  |                                                                                                                                  
|                                                                                                  | 
|Item 1.     Legal Proceedings                                                                     |  | 37                                                                                                                               
|                                                                                                  | 
|Item 6.     Exhibits and Reports on Form 8-K                                                      |  | 38                                                                                                                               
|                                                                                                  | 
|Signatures                                                                                        |  | 38                                                                                                                               
|                                                                                                  | 
|Certifications                                                                                    |  |                                                                                                                                  



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##### Table of Contents

PART I  FINANCIAL INFORMATION

ITEM 1.        CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NETOPIA, INC.

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)



|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ---------------------- | - | -------- | -
|                                                                                                                                                                            |  | June 30, 2006 |          |   | September 30, 2005 (1) |  
|                                                                                                                                                                            |  | (Unaudited)   |          |   |                        |  
|Assets                                                                                                                                                                      |  |               |          |   |                        |   |          |  
|Current assets:                                                                                                                                                             |  |               |          |   |                        |   |          |  
|Cash and cash equivalents                                                                                                                                                   |  | $             | 26,547   |   |                        | $ | 22,234   |  
|Trade accounts receivable, net of allowances for doubtful accounts of $143 and $144, respectively                                                                           |  |               | 17,057   |   |                        |   | 16,208   |  
|Inventories                                                                                                                                                                 |  |               | 5,930    |   |                        |   | 8,718    |  
|Prepaid expenses and other current assets                                                                                                                                   |  |               | 2,378    |   |                        |   | 1,102    |  
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|Total current assets                                                                                                                                                        |  |               | 51,912   |   |                        |   | 48,262   |  
|                                                                                                                                                                            |  |              
|Property and equipment, net                                                                                                                                                 |  |               | 2,556    |   |                        |   | 2,623    |  
|Intangible assets, net                                                                                                                                                      |  |               | 3,015    |   |                        |   | 4,037    |  
|Equity investment                                                                                                                                                           |  |               | 1,377    |   |                        |   | 1,032    |  
|Deposits and other assets                                                                                                                                                   |  |               | 351      |   |                        |   | 481      |  
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|TOTAL ASSETS                                                                                                                                                                |  | $             | 59,211   |   |                        | $ | 56,435   |  
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|Liabilities and Stockholders Equity                                                                                                                                        |  |               |          |   |                        |   |          |  
|Current liabilities:                                                                                                                                                        |  |               |          |   |                        |   |          |  
|Accounts payable                                                                                                                                                            |  | $             | 11,303   |   |                        | $ | 12,525   |  
|Deferred revenue                                                                                                                                                            |  |               | 3,323    |   |                        |   | 2,946    |  
|Other current liabilities                                                                                                                                                   |  |               | 5,417    |   |                        |   | 4,737    |  
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|Total current liabilities                                                                                                                                                   |  |               | 20,043   |   |                        |   | 20,208   |  
|Long-term liabilities:                                                                                                                                                      |  |               |          |   |                        |   |          |  
|Deferred revenue, long term                                                                                                                                                 |  |               | 198      |   |                        |   | 109      |  
|Other long-term liabilities                                                                                                                                                 |  |               | 163      |   |                        |   | 246      |  
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|TOTAL LIABILITIES                                                                                                                                                           |  |               | 20,404   |   |                        |   | 20,563   |  
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|Stockholders equity:                                                                                                                                                       |  |               |          |   |                        |   |          |  
|Common stock: $0.001 par value, 50,000,000 shares authorized; 25,837,902 and 25,428,412 shares issued and outstanding at June 30, 2006 and
September 30, 2005, respectively |  |               | 26       |   |                        |   | 25       |  
|Additional paid-in capital                                                                                                                                                  |  |               | 173,046  |   |                        |   | 168,075  |  
|Accumulated other comprehensive income                                                                                                                                      |  |               | 62       |   |                        |   | 45       |  
|Accumulated deficit                                                                                                                                                         |  |               | (134,327 | ) |                        |   | (132,273 | )
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|Total stockholders equity                                                                                                                                                  |  |               | 38,807   |   |                        |   | 35,872   |  
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                  |  | $             | 59,211   |   |                        | $ | 56,435   |  
|                                                                                                                                                                            |  |               |          |   |                        |   |          |  

(1) Derived from the audited Consolidated Balance Sheet dated September 30, 2005 included in Netopias Annual
Report on Form 10-K for the fiscal year ended September 30, 2005.

See accompanying notes.



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##### Table of Contents

NETOPIA, INC.

Condensed Consolidated Statements of Operations

Unaudited

(in thousands, except per share amounts)



|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|--------------------------------------------- |  | --------------------------- | ------ | - | -------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                              |  | Three Months Ended June 30, |        |   | Nine Months Ended June 30, |  
|                                              |  |                             |        |  
|                                              |  | 2006                        |        |   | 2005                       |   |        | 2006 |  |   | 2005   |  
|REVENUES:                                     |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Broadband equipment                           |  | $                           | 27,333 |   |                            | $ | 25,103 |      |  | $ | 71,099 |   |  | $ | 73,547 |  
|                                              |  |                             |        |  
|Broadband software and services               |  |                             | 3,154  |   |                            |   | 2,726  |      |  |   | 11,162 |   |  |   | 8,823  |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Total revenues                                |  |                             | 30,487 |   |                            |   | 27,829 |      |  |   | 82,261 |   |  |   | 82,370 |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|                                              |  |                             |        |  
|COST OF REVENUES:                             |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Broadband equipment                           |  |                             | 18,854 |   |                            |   | 18,655 |      |  |   | 48,751 |   |  |   | 54,907 |  
|Broadband software and services               |  |                             | 625    |   |                            |   | 489    |      |  |   | 1,734  |   |  |   | 1,139  |  
|Amortization of acquired technology           |  |                             | 300    |   |                            |   | 300    |      |  |   | 900    |   |  |   | 900    |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenues                        |  |                             | 19,779 |   |                            |   | 19,444 |      |  |   | 51,385 |   |  |   | 56,946 |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|GROSS PROFIT                                  |  |                             | 10,708 |   |                            |   | 8,385  |      |  |   | 30,876 |   |  |   | 25,424 |  
|                                              |  |                             |        |  
|OPERATING EXPENSES:                           |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Research and development                      |  |                             | 4,505  |   |                            |   | 3,400  |      |  |   | 12,616 |   |  |   | 10,009 |  
|Selling and marketing                         |  |                             | 5,502  |   |                            |   | 4,582  |      |  |   | 15,254 |   |  |   | 14,249 |  
|General and administrative                    |  |                             | 2,268  |   |                            |   | 2,561  |      |  |   | 6,805  |   |  |   | 6,785  |  
|Amortization of intangible assets             |  |                             | -      |   |                            |   | 86     |      |  |   | -      |   |  |   | 259    |  
|Restructuring costs                           |  |                             | -      |   |                            |   | -      |      |  |   | -      |   |  |   | 98     |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                      |  |                             | 12,275 |   |                            |   | 10,629 |      |  |   | 34,675 |   |  |   | 31,400 |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|                                              |  |                             |        |  
|OPERATING LOSS                                |  |                             | (1,567 | ) |                            |   | (2,244 | )    |  |   | (3,799 | ) |  |   | (5,976 | )
|Gain on equity investment                     |  |                             | 1,079  |   |                            |   | -      |      |  |   | 1,079  |   |  |   | -      |  
|Other income (expenses), net                  |  |                             | 344    |   |                            |   | (44    | )    |  |   | 703    |   |  |   | 259    |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|LOSS BEFORE INCOME TAXES                      |  |                             | (144   | ) |                            |   | (2,288 | )    |  |   | (2,017 | ) |  |   | (5,717 | )
|Provision for income taxes                    |  |                             | 12     |   |                            |   | 24     |      |  |   | 37     |   |  |   | 68     |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|NET LOSS                                      |  | $                           | (156   | ) |                            | $ | (2,312 | )    |  | $ | (2,054 | ) |  | $ | (5,785 | )
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|                                              |  |                             |        |  
|Net loss per common share, Basic and Diluted: |  | $                           | (0.01  | ) |                            | $ | (0.09  | )    |  | $ | (0.08  | ) |  | $ | (0.23  | )
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|                                              |  |                             |        |  
|Shares used in per-share calculation:         |  |                             | 25,817 |   |                            |   | 25,215 |      |  |   | 25,636 |   |  |   | 25,000 |  
|                                              |  |                             |        |   |                            |   |        |      |  |   |        |   |  |   |        |  

See accompanying notes. Net loss for the three and nine months ended June 30, 2006 includes stock-based
compensation expense of $1,442,801 and $3,985,155, respectively, under Statement of Financial Accounting Standards (SFAS) 123(R), Share Based Payment. There was no stock-based compensation expense under SFAS 123,
Accounting for Stock-Based Compensation, in the three and nine months ended June 30, 2005 because the Company had not yet adopted the recognition provisions of SFAS 123. Net loss including pro forma stock-based compensation expense
as previously disclosed in the notes to the Condensed Consolidated Financial Statements in the Form 10-Q for the three and nine months ended June 30, 2005 was $3.5 million and $9.5 million, respectively, or a loss of $(0.14) and $(0.38),
respectively, per basic and diluted share. See Note 7 to the Condensed Consolidated Financial Statements for additional information.



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##### Table of Contents

NETOPIA, INC.

Condensed Consolidated Statements of Cash Flows

Unaudited

(in thousands)



|                                                                                        |  |                            |        |   |      |   |        |  
|--------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                        |  | Nine Months Ended June 30, |       
|                                                                                        |  | 2006                       |        |   | 2005 |  
|Cash flows from operating activities:                                                   |  |                            |        |  
|Net loss                                                                                |  | $                          | (2,054 | ) |      | $ | (5,785 | )
|Adjustments to reconcile net loss to net cash provided by operating activities:         |  |                            |        |   |      |   |        |  
|Depreciation and amortization                                                           |  |                            | 1,783  |   |      |   | 2,695  |  
|Stock-based compensation related to employee stock options and employee stock purchases |  |                            | 3,994  |   |      |   | -      |  
|Changes in allowance for doubtful accounts                                              |  |                            | (16    | ) |      |   | (30    | )
|Gain on sale of equity investment                                                       |  |                            | (1,079 | ) |      |   | -      |  
|Restructuring costs                                                                     |  |                            | -      |   |      |   | (459   | )
|Charge for impairment of capitalized software costs                                     |  |                            | -      |   |      |   | 99     |  
|Changes in operating assets and liabilities:                                            |  |                            |        |   |      |   |        |  
|Trade accounts receivable                                                               |  |                            | (833   | ) |      |   | (503   | )
|Inventories                                                                             |  |                            | 2,788  |   |      |   | 737    |  
|Prepaid expenses and other assets                                                       |  |                            | (1,276 | ) |      |   | 260    |  
|Accounts payable and accrued liabilities                                                |  |                            | (565   | ) |      |   | 3,021  |  
|Deferred revenue                                                                        |  |                            | 466    |   |      |   | (325   | )
|Other liabilities                                                                       |  |                            | (60    | ) |      |   | (935   | )
|                                                                                        |  |                            |        |   |      |   |        |  
|Net cash provided by (used in) operating activities                                     |  |                            | 3,148  |   |      |   | (1,225 | )
|                                                                                        |  |                            |        |   |      |   |        |  
|                                                                                        |  |                           
|Cash flow from investing activities:                                                    |  |                            |        |   |      |   |        |  
|                                                                                        |  |                           
|Purchase of furniture, fixtures and equipment                                           |  |                            | (564   | ) |      |   | (1,151 | )
|Sale of equity investment                                                               |  |                            | 734    |   |      |   | -      |  
|                                                                                        |  |                            |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                                     |  |                            | 170    |   |      |   | (1,151 | )
|                                                                                        |  |                            |        |   |      |   |        |  
|                                                                                        |  |                           
|Cash flow from financing activities:                                                    |  |                            |        |   |      |   |        |  
|                                                                                        |  |                           
|Repayment of term loans                                                                 |  |                            | -      |   |      |   | (104   | )
|Proceeds from the issuance of common stock                                              |  |                            | 978    |   |      |   | 1,335  |  
|                                                                                        |  |                            |        |   |      |   |        |  
|Net cash provided by financing activities                                               |  |                            | 978    |   |      |   | 1,231  |  
|                                                                                        |  |                            |        |   |      |   |        |  
|                                                                                        |  |                           
|Effect of changes in foreign currency exchange rates                                    |  |                            | 17     |   |      |   | (3     | )
|                                                                                        |  |                           
|Net increase (decrease) in cash and cash equivalents                                    |  |                            | 4,313  |   |      |   | (1,148 | )
|Cash and cash equivalents, beginning of period                                          |  |                            | 22,234 |   |      |   | 23,973 |  
|                                                                                        |  |                            |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                                |  | $                          | 26,547 |   |      | $ | 22,825 |  
|                                                                                        |  |                            |        |   |      |   |        |  

See accompanying notes.



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##### Table of Contents

NETOPIA, INC.

Condensed Consolidated Statements of Stockholders Equity and Comprehensive Loss

Unaudited

(in thousands, except share amounts)



|                                                                                                |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  |          
|----------------------------------------------------------------------------------------------- |  | ------------ |  | ------------------------- | --- | ------------------- | - | ------------------------------------------- |  | ------------------------- |  | - | --- |  | ---------
|                                                                                                |  | Common Stock |  | AdditionalPaid-in Capital |     | Accumulated Deficit |   | AccumulatedOtherComprehensive Income (Loss) |  | TotalStockholders Equity
|                                                                                                |  | Shares       |  | Amount                    |     |                     |   |                                            
|Nine Months Ended June 30, 2005                                                                 |  |              |  |                           |     |                     |   |                                             |  |                           |  |  
|                                                                                                |  |              |  |                           |     |                    
|Balance, September 30, 2004                                                                     |  | 24,717,503   |  | $                         | 25  |                     | $ | 166,245                                     |  | $(125,140)                |  |   | $  |  | $  41,130
|                                                                                                |  |              |  |                           |     |                    
|Net Loss                                                                                        |  |              |  |                           |     |                     |   |                                             |  | (5,785)                   |  |   |     |  | (5,785)  
|Foreign Currency Translation adjustments                                                        |  |              |  |                           |     |                     |   |                                             |  |                           |  |   | 3   |  | 3        
|                                                                                                |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  |          
|Comprehensive Loss                                                                              |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  | (5,788)  
|                                                                                                |  |              |  |                           |     |                    
|Exercise of stock options                                                                       |  | 246,069      |  |                           |    |                     |   | 609                                         |  |                           |  |   |     |  | 609      
|Issuance of common stock under ESPP                                                             |  | 261,651      |  |                           |    |                     |   | 729                                         |  |                           |  |   |     |  | 729      
|                                                                                                |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  |          
|                                                                                                |  |              |  |                           |     |                    
|Balance, June 30, 2005                                                                          |  | 25,225,223   |  | $                         | 25  |                     | $ | 167,583                                     |  | $(130,925)                |  |   | $3  |  | $36,670  
|                                                                                                |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  |          
|                                                                                                |  |              |  |                           |     |                    
|Nine Months Ended June 30, 2006                                                                 |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  |          
|                                                                                                |  |              |  |                           |     |                    
|Balance, September 30, 2005                                                                     |  | 25,428,412   |  |                           | $25 |                     | $ | 168,075                                     |  | $(132,273)                |  |   | $45 |  | $35,872  
|                                                                                                |  |              |  |                           |     |                    
|Net Loss                                                                                        |  |              |  |                           |     |                     |   |                                             |  | (2,054)                   |  |   |     |  | (2,054)  
|Foreign Currency Translation adjustments                                                        |  |              |  |                           |     |                     |   |                                             |  |                           |  |   | 17  |  | 17       
|                                                                                                |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  |          
|Comprehensive Loss                                                                              |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  | (2,037)  
|                                                                                                |  |              |  |                           |     |                    
|Exercise of stock options                                                                       |  | 174,205      |  |                           |    |                     |   | 382                                         |  |                           |  |   |     |  | 382      
|Issuance of common stock under ESPP                                                             |  | 235,285      |  |                           | 1   |                     |   | 595                                         |  |                           |  |   |     |  | 596      
|Stock-based compensation expense related to employee stock options and employee stock purchases |  |              |  |                           |     |                     |   | 3,994                                       |  |                           |  |   |     |  | 3,994    
|                                                                                                |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  |          
|                                                                                                |  |              |  |                           |     |                    
|Balance, June 30, 2006                                                                          |  | 25,837,902   |  | $                         | 26  |                     | $ | 173,046                                     |  | $(134,327)                |  | $ | 62  |  | $38,807  
|                                                                                                |  |              |  |                           |     |                     |   |                                             |  |                           |  |   |     |  |          

See accompanying notes.



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##### Table of Contents

NETOPIA, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)



|(1) | Description of Business
|--- | -----------------------

Netopia, Inc. (the Company) is a developer and
provider of high performance broadband customer premises networking equipment and carrier-class software for the remote management of broadband services and equipment. The Company also develops and provides broadband enabled services and remote
management software for enterprises technical support, help-desks and personal computers.



|(2) | Summary of Significant Accounting Policies
|--- | ------------------------------------------

Fiscal
Year:    The Companys fiscal year is the 12-months ending September 30.

Basis of Presentation:    The
accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01
of Regulation S-X. Accordingly, they do not include all disclosures required by accounting principles generally accepted in the United States of America. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended September 30, 2005.

In the opinion of management, the unaudited interim financial statements included herein reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Companys consolidated financial position and
the results of operations and cash flows for the periods presented. The results of operations for the periods presented are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2006
(fiscal year 2006).

Stock-Based Compensation:    On October 1, 2005, the Company adopted SFAS 123(R), which requires the
measurement and recognition of compensation expense for share-based payment awards made to the Companys employees and non-employee directors, including stock options and employee stock purchases made pursuant to the Employee Stock Purchase
Plan (ESPP), based on estimated fair values.

The Company adopted SFAS 123(R) using the modified prospective method, which requires us to record
compensation expense for all awards granted after the date of adoption, and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Accordingly, prior period amounts presented herein have not been
restated to reflect the adoption of SFAS 123(R). The fair value concepts were not changed significantly in SFAS 123(R); however, in adopting SFAS 123(R), companies must choose among alternative valuation models and amortization assumptions. After
assessing alternative valuation models and amortization assumptions, the Company will continue using the Black-Scholes option-pricing formula. The Company recognizes compensation cost on a straight-line basis over the requisite service period for
each separately vesting portion of share-based payment awards as if the award was, in substance, multiple awards. The Company will reconsider use of this model if additional information becomes available in the future that indicates another model
would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated using this model. Under SFAS No. 123, Accounting for Stock Based Compensation (SFAS 123), the
Company was not required to estimate forfeitures in expense calculation for the stock compensation pro forma footnote disclosure; however, SFAS 123(R) requires an estimate of forfeitures and upon adoption the Company changed methodology to include
an estimate of forfeitures. The adoption of SFAS 123(R) had no effect on cash flows from operating activities.

Per Share
Calculations:    Basic net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of
common shares and dilutive potential common shares outstanding. Diluted net loss per share is computed using the weighted-average number of common



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shares and excludes dilutive potential common shares outstanding, as their effect is antidilutive. Dilutive potential common shares consist of employee stock options,
which in aggregate were approximately 7.7 million options outstanding at June 30, 2006.

Statement of Financial Accounting Standards No. 128,
Earnings per Share, requires that employee stock options be treated as potential common shares outstanding in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect of in-the-money options, which is
calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service
that the Company has not yet recognized, and the amount of tax benefits, if any, that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares.

Estimates:    The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to
make estimates and judgments that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying notes. Estimates are used for revenue recognition, allowance for doubtful accounts and sales returns, reserves for
excess and obsolete inventory, warranty costs, compensation expense for share-based payment awards, investment impairments, income taxes, service costs, and loss contingencies, among others. The actual results experienced by the Company may differ
materially from managements estimates.

Reclassifications: Certain reclassifications have been made to prior year balances in order to conform to the
current years presentation.

Fair Value of Financial Instruments:    The fair value of cash and cash equivalents, accounts
receivable and accounts payable for all periods presented approximates their respective carrying amounts because of the short maturity of these financial instruments.



|(3) | Intangible Assets
|--- | -----------------

Intangible assets consisted of goodwill and purchased intangibles,
as follows:



|                              |  |                |        |   |                    |   |        |  
|----------------------------- |  | -------------- | ------ | - | ------------------ | - | ------ | -
|                              |  | June 30, 2006  |        |   | September 30, 2005 |  
|                              |  | (in thousands) |       
|Goodwill                      |  | $              | 1,668  |   |                    | $ | 1,668  |  
|Purchased intangibles         |  |                | 8,615  |   |                    |   | 8,615  |  
|                              |  |                |        |   |                    |   |        |  
|                              |  |                | 10,283 |   |                    |   | 10,283 |  
|Less accumulated amortization |  |                | (7,268 | ) |                    |   | (6,246 | )
|                              |  |                |        |   |                    |   |        |  
|Intangible Assets, net        |  | $              | 3,015  |   |                    | $ | 4,037  |  
|                              |  |                |        |   |                    |   |        |  

Goodwill:    The Companys goodwill resulted from the acquisitions of JadeSail in October
2003 and WebOrder in March 2000, each of which became part of the broadband software and services segment.

Purchased Intangibles:    At
June 30, 2006, the Companys purchased intangible assets consisted of developed product technology and a marketing agreement. The table below presents details of the Companys purchased intangible assets. The Companys purchased
intangible assets are allocated primarily to the broadband equipment segment.



|                            |  |                |  |                    |  |        
|--------------------------- |  | -------------- |  | ------------------ |  | -------
|                            |  | Technology     |  | MarketingAgreement |  | Total  
|                            |  | (in thousands)
|Balance, September 30, 2005 |  | $2,232         |  | $137               |  | $2,369 
|Amortization                |  | (900)          |  | (122)              |  | (1,022)
|                            |  |                |  |                    |  |        
|Balance, June 30, 2006      |  | $1,332         |  | $15                |  | $1,347 
|                            |  |                |  |                    |  |        



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The Companys purchased intangible assets will be fully amortized by the end of fiscal year 2007. Estimated future
amortization is $325,000 in the fourth quarter of fiscal year 2006 and $1,022,000 in fiscal year 2007.



|(4) | Inventories
|--- | -----------

Inventories consisted of the following:



|                |  |                |  |                  
|--------------- |  | -------------- |  | -----------------
|                |  | June 30,2006   |  | September 30,2005
|                |  | (in thousands)
|Raw materials   |  | $910           |  | $  1,783         
|Work in process |  | 72             |  | 43               
|Finished goods  |  | 4,948          |  | 6,892            
|                |  |                |  |                  
|Total           |  | $5,930         |  | $  8,718         
|                |  |                |  |                  



|(5) | Property and Equipment
|--- | ----------------------

Property and equipment consisted of the following:



|                               |  |                |         |   |                   |   |         |  
|------------------------------ |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                               |  | June 30,2006   |         |   | September 30,2005 |  
|                               |  | (in thousands) |        
|Computers                      |  | $              | 7,206   |   |                   | $ | 7,064   |  
|Machinery and equipment        |  |                | 3,640   |   |                   |   | 3,415   |  
|Furniture and fixtures         |  |                | 1,675   |   |                   |   | 1,684   |  
|Manufacturing tooling          |  |                | 1,456   |   |                   |   | 1,310   |  
|Leasehold improvements         |  |                | 436     |   |                   |   | 376     |  
|                               |  |                |         |   |                   |   |         |  
|                               |  |                | 14,413  |   |                   |   | 13,849  |  
|Less: accumulated depreciation |  |                | (11,857 | ) |                   |   | (11,226 | )
|                               |  |                |         |   |                   |   |         |  
|Total                          |  | $              | 2,556   |   |                   | $ | 2,623   |  
|                               |  |                |         |   |                   |   |         |  



|(6) | Warranty Liability
|--- | ------------------

Warranty liability is recorded as a component of other current
liabilities on the Companys Condensed Consolidated Balance Sheets. For the Companys broadband equipment products, the Company generally provides a one-year to two-year warranty. The Company generally does not offer a warranty on its
broadband software and services products. The Company accrues for its estimated product warranty costs at the time of shipment. Product warranty costs are estimated based upon the Companys historical experience.

The following table summarizes the activity related to the product warranty liability:



|                               |  |                            |     |   |                           |   |     |      |  |   |      |   |  |   |      |  
|------------------------------ |  | -------------------------- | --- | - | ------------------------- | - | --- | ---- |  | - | ---- | - |  | - | ---- | -
|                               |  | Three Months EndedJune 30, |     |   | Nine Months EndedJune 30, |  
|                               |  | 2006                       |     |   | 2005                      |   |     | 2006 |  |   | 2005 |  
|                               |  | (in thousands)             |    
|Balance at beginning of period |  | $                          | 260 |   |                           | $ | 138 |      |  | $ | 310  |   |  | $ | 140  |  
|Utilized                       |  |                            | (69 | ) |                           |   | (91 | )    |  |   | (190 | ) |  |   | (220 | )
|Charged to costs and expenses  |  |                            | 77  |   |                           |   | 86  |      |  |   | 148  |   |  |   | 213  |  
|                               |  |                            |     |   |                           |   |     |      |  |   |      |   |  |   |      |  
|Balance at end of period       |  | $                          | 268 |   |                           | $ | 133 |      |  | $ | 268  |   |  | $ | 133  |  
|                               |  |                            |     |   |                           |   |     |      |  |   |      |   |  |   |      |  



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|(7) | Stock Option Plans
|--- | ------------------

The Company has three share-based plans under which non-qualified
and incentive stock options have been granted to employees, non-employees and board members. Options granted under any of the three share-based plans have a maximum contractual term of 10 years. Stock options generally vest over service periods that
range from 2 to 4 years. The Company also has an employee stock purchase plan for all eligible employees.

1996 Stock Option Plan.    In
April 1996, the Company adopted the 1996 Stock Option Plan (the 1996 Plan) providing for the issuance of incentive or non-statutory options to directors, employees, and non-employee consultants. Options are granted at the discretion of the Board of
Directors or the Compensation Committee of the Board of Directors. Incentive stock options may be granted at not less than 100% of the fair market value per share and non-statutory stock options may be granted at not less than 85% of the fair market
value per share at the date of grant as determined by the Board of Directors or the Compensation Committee, except for options granted to a person owning greater than 10% of the total combined voting power of all classes of stock of the Company, for
which the exercise price of the options must be not less than 110% of the fair market value. Included in the 1996 Plan is a provision for the automatic grant of non-statutory options to non-employee directors of the Company. The current provisions
relating to the automatic grant of options to directors are described below. The 1996 Plan has expired, and as of June 30, 2006, no additional shares are available for grant under the 1996 plan.

2000 Stock Incentive Plan.    In October 2000, the Company adopted the 2000 Stock Incentive Plan (the 2000 Plan) providing for issuance of non-statutory
options and restricted stock to employees, officers, directors, consultants, independent contractors and advisors of the Company or any subsidiary of the Company. Options and restricted stock awards granted under the 2000 Plan are granted at the
discretion of the Board of Directors or the Compensation Committee of the Board of Directors. The 2000 Plan is not a stockholder approved stock option plan and is intended to comply with the exception for broadly based option plans in which a
majority of the participants are rank and file employees not officers or directors, and a majority of the grants are made to such employees. Only nonqualified stock options that do not qualify as incentive stock options within the meaning of
Section 422(b) of the Internal Revenue Code may be granted under this Plan. The Board of Directors or the Compensation Committee will determine the exercise price of an option when the option is granted and may be not less than the par value of
the shares on the date of grant. Officers and directors will not receive any additional awards under the 2000 Plan. A restricted stock award is an offer by the Company to sell to an eligible person shares that are subject to restrictions. The
purchase price of shares sold pursuant to a restricted stock award will be determined by the Compensation Committee on the date the restricted stock award is granted and may be not less than the par value of the shares on the date of grant.
Restricted stock awards shall be subject to such restrictions as the Board of Directors or the Compensation Committee may impose. As of June 30, 2006, there were no restricted stock awards granted under the 2000 Plan. As of June 30, 2006,
there are 971,102 shares authorized but unissued and 306,493 shares available for grant under the 2000 plan.

2002 Equity Incentive
Plan.    In December 2001, the Company adopted the 2002 Equity Incentive Plan (the 2002 Plan) providing for the issuance of incentive or non-statutory options, stock awards and other equity awards to directors, employees, and
non-employee consultants. The Companys stockholders approved the 2002 Plan at the Annual Stockholder Meeting in January 2002. The 2002 Plan is a successor to the 1996 Plan. Options and other awards are granted at the discretion of the Board of
Directors or the Compensation Committee of the Board of Directors. Incentive stock options may be granted at not less than 100% of the fair market value per share and non-statutory stock options may be granted at not less than 85% of the fair market
value per share at the date of grant as determined by the Board of Directors or the Compensation Committee. Included in the 2002 Plan is a provision for the automatic grant of non-statutory options to non-employee directors of the Company. The
current provisions relating to the automatic grant of options to directors are described below.

The initial number of shares of common stock available for issuance
under the 2002 Plan was 750,000 shares. The number of shares of common stock available for issuance under the 2002 Plan automatically increases on the first trading day of each calendar year beginning 2003 by an amount equal to four and
three-quarter percent (4.75%) of the shares of common stock outstanding on December 31 of the immediately preceding calendar year, provided, however, that no such automatic annual increase may exceed 1,000,000 shares. As a result of this
automatic increase provision, an additional 1,000,000,



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1,000,000, 1,000,000 and 898,081 shares of common stock became available on January 3, 2006, January 3, 2005, January 2, 2004 and
January 2, 2003, respectively, for issuance under the 2002 Plan. As of June 30, 2006, there are 4.2 million shares authorized but unissued and 505,860 shares available for grant under the 2002 plan.

Automatic Option Grant Programs in Stock Option Plans.    Amendments to the Companys Automatic Option Grant Programs that are included in the 1996
Stock Option Plan and 2002 Equity Incentive Plan to increase the number of options granted to non-employee directors of the Company were approved at the Companys Annual Meeting of Stockholders in January 2003. As amended, the Automatic Option
Grant Programs provide that each non-employee director who is first elected or appointed on or after the date of the 2003 Annual Meeting of Stockholders will receive the grant of an option to purchase 50,000 shares of common stock. This initial
grant vests ratably over a four year period, subject to continued service as a director. The Automatic Option Grant Programs also provide for the grant on the date of each annual stockholder meeting beginning with the 2003 Annual Meeting of
Stockholders of (a) an option to purchase 15,000 shares of common stock to each non-employee director, and (b) an additional option to purchase 5,000 shares of common stock to each non-employee director who is a member of the Audit
Committee of the Companys Board of Directors. The automatic annual grant vests one year after the grant date, subject to continued service as a director.

On
October 1, 2005, the Company adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for share-based payment awards made to the Companys employees and directors, including employee stock options and
employee stock purchases related to the Employee Stock Purchase Plan. Accordingly, stock-based compensation cost is measured at grant date, based on the estimated fair value of the award, and is recognized as expense over the employee requisite
service period. The Companys stock compensation is accounted for as an expense and an addition to equity. The Company previously applied Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations and provided the required pro forma disclosures of SFAS 123, Accounting for Stock-Based Compensation.

Prior to the adoption
of SFAS 123(R)

Prior to the adoption of SFAS 123(R), the Company provided the disclosures required under SFAS 123 as amended by SFAS 148, Accounting for
Stock-Based Compensation  Transition and Disclosures. No employee stock-based compensation was reflected in net loss for the three and nine months ended June 30, 2005, because all options granted under those plans had an exercise
price equal to the market value of the underlying common stock on the date of grant.

Impact of adoption of SFAS 123(R)

The Company elected to adopt the modified prospective application method as provided by SFAS 123(R). Accordingly, during the three and nine months ended June 30, 2006, the
Company recorded stock-based compensation cost totaling the amount that would have been recognized had the fair value method been applied since the effective date of SFAS 123. Previously reported amounts have not been restated. The following table
summarizes the classification of stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123(R) for the three and nine months ended June 30, 2006, which was allocated as follows:



|                                                                |  |                                  |       |                                 |   |      
|--------------------------------------------------------------- |  | -------------------------------- | ----- | ------------------------------- | - | -----
|                                                                |  | Three Months Ended June 30, 2006 |       | Nine Months Ended June 30, 2006
|                                                                |  | (in thousands)                  
|Stock-based compensation expense was included in:               |  |                                  |       |                                 |   |      
|Cost of revenues  broadband equipment                          |  | $                                | 72    |                                 | $ | 140  
|                                                                |  |                                  |       |                                 |   |      
|Research and development                                        |  |                                  | 590   |                                 |   | 1,549
|Selling and marketing                                           |  |                                  | 353   |                                 |   | 834  
|General and administrative                                      |  |                                  | 428   |                                 |   | 1,462
|                                                                |  |                                  |       |                                 |   |      
|Stock-based compensation expense included in operating expenses |  |                                  | 1,371 |                                 |   | 3,845
|                                                                |  |                                  |       |                                 |   |      
|Stock-based compensation expense included in net loss           |  | $                                | 1,443 |                                 | $ | 3,985
|                                                                |  |                                  |       |                                 |   |      



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The table below reflects basic and diluted net income (loss) per share for the three months and nine months ended June 30,
2006 compared with the pro forma information for the three months and nine months ended June 30, 2005 (in thousands except per-share amounts):



|                                                                                                |  |                                         |       |   |                           |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------------------------------------------------------------------- |  | --------------------------------------- | ----- | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                |  | Three Months EndedJune 30,              |       |   | Nine Months EndedJune 30, |  
|                                                                                                |  | 2006                                    |       |   | 2005                      |   |        | 2006 |  |   | 2005   |  
|                                                                                                |  | (in thousands except per share amounts) |      
|Net loss - as reported for the prior period                                                     |  |                                         | N/A   |   |                           | $ | (2,312 | )    |  |   | N/A    |   |  | $ | (5,785 | )
|Stock-based compensation expense related to employee stock options and employee stock purchases |  | $                                       | 1,443 |   |                           | $ | 1,152  |      |  | $ | 3,985  |   |  | $ | 3,735  |  
|                                                                                                |  |                                         |       |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net loss - including the effect of stock-based compensation expense                             |  | $                                       | (156  | ) |                           | $ | (3,464 | )    |  | $ | (2,054 | ) |  | $ | (9,520 | )
|                                                                                                |  |                                         |       |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted loss per share  as reported for the prior period                             |  |                                         | N/A   |   |                           | $ | (0.09  | )    |  |   | N/A    |   |  | $ | (0.25  | )
|                                                                                                |  |                                         |       |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted loss per share - including the effect of stock-based compensation             |  | $                                       | (0.01 | ) |                           | $ | (0.14  | )    |  | $ | (0.08  | ) |  | $ | (0.38  | )
|                                                                                                |  |                                         |       |   |                           |   |        |      |  |   |        |   |  |   |        |  

As of October 1, 2005, the Company had an unrecorded deferred stock-based compensation balance related to stock options
of $5.7 million before estimated forfeitures. In the Companys pro forma disclosure prior to the adoption of SFAS 123(R), the Company accounted for forfeitures upon occurrence. SFAS 123(R) requires forfeitures to be estimated at the time of
grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Accordingly, as of October 1, 2005, the Company estimated that the stock based compensation awards not expected to vest was $0.9 million,
and therefore, the unrecorded deferred stock-based compensation balance related to stock options was adjusted to $4.8 million after forfeitures.

During the nine
months ended June 30, 2006, the Company granted 2,365,750 stock options with an estimated total grant-date fair value of $6.8 million. Of this amount, the Company estimated that the stock-based compensation for awards not expected to vest was
$1.3 million.

As of June 30, 2006, the unrecorded deferred stock-based compensation balance related to stock options was $7.2 million net of estimated
forfeitures. The amount of stock based compensation capitalized, as inventory on June 30, 2006 was $6,000. The Company elected not to capitalize any stock-based compensation to inventory at October 1, 2005 when the provisions of SFAS
123(R) were initially adopted.

Stock Option Plans

The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option-pricing model using the following estimates:



|                         |  |                          |   |  |      |  
|------------------------ |  | ------------------------ | - |  | ---- | -
|                         |  | Nine MonthsEndedJune 30, |  
|                         |  | 2006                     |   |  | 2005 |  
|Expected life (in years) |  | 2.97                     |   |  | 3.23 |  
|Expected volatility      |  | 121                      | % |  | 354  | %
|Risk-free interest rate  |  | 5.13                     | % |  | 3.67 | %
|Expected dividend yield  |  | -                        |   |  | -    |  

Valuation Assumptions

Expected
volatility is based on the historical volatility of the Companys common stock to estimate the future expected volatility. The risk-free interest rates are taken from the Federal Yield Curve Rates as published by the Federal Reserve and
represent the yields on actively traded treasury securities for terms equal or approximately equal to the expected term of the options. The expected term calculation is based on observed historical option exercise behavior of the Companys
employees and the options contractual



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##### Table of Contents

terms. The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends.

The Black-Scholes weighted average fair value of employee stock options granted during the nine months ended June 30, 2006 and 2005 was $2.87 and $3.18, respectively.

As of June 30, 2006, the weighted-average remaining contractual terms of options outstanding and currently exercisable are 7.25 and 5.87 years, respectively.

The following table summarizes activity under the Companys stock option plans:



|                                     |  |                     |   |  |                               |     
|------------------------------------ |  | ------------------- | - |  | ----------------------------- | ----
|Stock options                        |  | Shares underOptions |   |  | Weightedaverageexercise price
|Outstanding as of September 30, 2005 |  | 5,709,856           |   |  | $                             | 4.33
|Options granted                      |  | 525,000             |   |  |                               | 2.68
|Options exercised                    |  | (40,761             | ) |  |                               | 2.17
|Options cancelled                    |  | (45,734             | ) |  |                               | 3.84
|                                     |  |                     |   |  |                               |     
|Outstanding as of December 31, 2005  |  | 6,148,361           |   |  |                               | 4.20
|Options granted                      |  | 1,448,625           |   |  |                               | 3.37
|Options exercised                    |  | (49,997             | ) |  |                               | 1.98
|Options cancelled                    |  | (88,702             | ) |  |                               | 3.02
|                                     |  |                     |   |  |                               |     
|Outstanding as of March 31, 2006     |  | 7,458,287           |   |  |                               | 4.07
|Options granted                      |  | 392,125             |   |  |                               | 4.70
|Options exercised                    |  | (83,447             | ) |  |                               | 2.33
|Options cancelled                    |  | (98,590             | ) |  |                               | 3.75
|                                     |  |                     |   |  |                               |     
|Outstanding as of June 30, 2006      |  | 7,668,375           |   |  | $                             | 4.13
|                                     |  |                     |   |  |                               |     
|Exercisable as of June 30, 2006      |  | 4,493,472           |   |  | $                             | 4.55
|                                     |  |                     |   |  |                               |     

As of June 30, 2006, the aggregate intrinsic value of stock options outstanding and exercisable was $12.2 million and
$6.2 million, respectively.

Employee Stock Purchase Plan

In March 2005,
the Company approved the adoption of the 2005 Employee Stock Purchase Plan and reserved a total of 1,225,000 shares of common stock for issuance under the plan. Employees may purchase shares of common stock at a price per share that is 85% of the
lesser of the fair market value as of the beginning or the end of the semi-annual option period. The Companys and its subsidiaries employees are all eligible to participate in the Plan and purchase shares of the Companys common
stock through accumulated payroll deductions. As of June 30, 2006, 808,814 shares were reserved for issuance under the plan. The value of rights to purchase shares under the plan were estimated at the date of grant using the following weighted
average assumptions:



|                         |  |                            |  |      
|------------------------ |  | -------------------------- |  | -----
|                         |  | Three Months EndedJune 30,
|                         |  | 2006                       |  | 2005 
|Expected life (in years) |  | 0.5 to 2                   |  | 2    
|Expected volatility      |  | 52%  83%                  |  | 221% 
|Risk-free interest rate  |  | 5.21%                      |  | 3.66%
|Expected dividend yield  |  | -                          |  | -    

Valuation Assumptions

Pursuant
to the guidance in SFAS 123(R) and Staff Accounting Bulletin No. 107 (SAB 107), the Company uses historical volatility as an estimate of expected volatility for purposes of calculating stock-based compensation expense using the Black-Scholes
model. During the first 9 months of fiscal 2006, the Company changed its assumption of historical volatility from 10 years to a range of 6 months to 2 years



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##### Table of Contents

for purposes of calculating stock-based compensation expense related to share-based payment awards under the Companys ESPP. The Company believes that a range of
6 months to 2 years results in a more accurate estimate of expected volatility for the purpose of valuing stock-based compensation related to the Companys ESPP.



|(8) | Commitments and Contingencies
|--- | -----------------------------

Operating Lease
Commitments.    The Company conducts its operations in leased facilities under operating lease agreements expiring at various dates through 2014. The following is a summary of future minimum rental payments required under
these leases that have initial or remaining non-cancelable lease terms in excess of one year (the 2006 amount is for the three months remaining in the fiscal year):



|                           |  |                           |     |      |   |       |  |      |       |      |   |            |  |       |     |  |   |     |  |   |      
|-------------------------- |  | ------------------------- | --- | ---- | - | ----- |  | ---- | ----- | ---- | - | ---------- |  | ----- | --- |  | - | --- |  | - | -----
|                           |  | Year ending September 30,
|                           |  | 2006                      |     | 2007 |   | 2008  |  | 2009 |       | 2010 |   | Thereafter |  | Total
|                           |  | (in thousands)           
|Property lease obligations |  | $                         | 337 |      | $ | 1,371 |  | $    | 1,076 |      | $ | 466        |  | $     | 335 |  | $ | 110 |  | $ | 3,695
|                           |  |                           |     |      |   |       |  |      |       |      |   |            |  |       |     |  |   |     |  |   |      

Purchase Commitments with Outsourcing Manufacturers and Suppliers.    The Company has purchase
commitments with its outsourcing manufacturers. Our outsourcing manufacturers procure component inventory on our behalf based on our production orders. The Company is obligated to purchase component inventory that the outsourcing manufacturer
procures in accordance with the orders, unless cancellation is given within applicable lead times. These commitments are reflected in our financial statements as a liability once title for goods has transferred, services have been received and/or
payments related to the obligations become due. At June 30, 2006, purchase commitments totaled $21.2 million of which $0.6 million represented non-inventory purchase commitments with suppliers.

Foreign Currency Derivatives.    The Company has entered into foreign currency forward contracts to hedge foreign currency denominated receivables. The
Company does not enter into foreign exchange forward contracts for trading purposes. Gains and/or losses on the contracts are included in other income (expenses) in the Consolidated Statement of Operations. The Companys foreign exchange
forward contracts usually range from one to three months from origination to maturity. Forward contracts involve agreements to sell foreign currency at specified rates at future dates. The following table presents the fair value amount of currency
exchange forward contracts:



|                                              |        |                                                       |                        |                    |                   |          |        |        |                        |        |                |         
|--------------------------------------------- | ------ | ----------------------------------------------------- | ---------------------- | ------------------ | ----------------- | -------- | ------ | ------ | ---------------------- | ------ | -------------- | --------
|                                              |        | June 30, 2006                                         |                        | September 30, 2005
|                                              | Amount |                                                       | ContractedForward Rate |                    | SettlementDate(s) |          | Amount |        | ContractedForward Rate |        | SettlementDate
|                                              |        | (Amount in thousands, except contracted forward rate)
|Principal (notional) amounts in U.S. dollars: |        |                                                       |                        |                    |                   |          |        |        |                        |        |                |         
|Euro forward exchange contract                |        | $278                                                  |                        | $1.245             |                   | Jul-2006 |        | $2,148 |                        | $1.212 |                | Oct-2005
|Euro forward exchange contract                |        | 1,076                                                 |                        | 1.273              |                   | Jul-2006 |        |        |                        |        |                |         
|Euro forward exchange contract                |        | 1,423                                                 |                        | 1.271              |                   | Aug-2006 |        |        |                        |        |                |         
|Euro forward exchange contract                |        | 991                                                   |                        | 1.271              |                   | Sep-2006 |        |        |                        |        |                |         
|Swiss franc forward exchange contract         |        | 232                                                   |                        | 0.816              |                   | Aug-2006 |        |        |                        |        |                |         
|Swiss franc forward exchange contract         |        | 800                                                   |                        | 0.814              |                   | Aug-2006 |        |        |                        |        |                |         
|                                              |        |                                                       |                        |                    |                   |          |        |        |                        |        |                |         
|                                              |        | $4,800                                                |                        |                    |                   |          |        | $2,148 |                        |        |                |         

Litigation.On December 3, 2004, the United States District Court for the Northern District of California issued
an order consolidating previously filed purported class action cases under the name In re Netopia, Inc. Securities Litigation, and appointing lead plaintiffs and plaintiffs counsel. On June 29, 2005, the lead plaintiffs filed their
consolidated amended complaint. The consolidated amended complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act). The consolidated amended complaint alleges that
during the purported class period, November 6, 2003 through August 16, 2004, we made false and misleading statements or failed to disclose material facts, and that the market price of our common stock was artificially inflated as a result
of such alleged conduct. On June 21, 2006, the court granted the plaintiffs motion for class certification. We believe that we have strong defenses to the claims asserted in the consolidated amended complaint.



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We intend to defend the case vigorously. We currently cannot estimate the extent of the potential damages in this dispute.

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 alleged
misstatements described above in connection with the purported class action described above. 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. On March 3, 2006, the plaintiffs 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. We currently cannot estimate the extent of the potential damages in this dispute.

In April 2005, we learned that the United States Attorney for the Northern District of California has opened an investigation following a referral by the SEC. We do not know the
scope or focus of the investigation.

In January 2005, we were notified by the Occupational Health and Safety Administration (OSHA) that we were 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
alleged that we terminated them in retaliation for their participation in the internal accounting review conducted by the audit committee in 2004. On May 11, 2005, following its investigation, OSHA advised us that the complaint was determined
to have no merit. On August 31, 2005, the two former employees refiled these claims in the United States District Court for the Northern District of Texas in an action entitled Frankl v. Netopia et al. The complaint names the Company and
certain current and former officers and directors as defendants. The plaintiffs will be filing a motion to stay this action. We believe that our defenses to this action are strong and intend to defend it vigorously. We currently cannot estimate the
extent of the potential damages in this dispute. One of the plaintiffs in this action is a defendant in an action filed on March 29, 2006 and pending in the United States District Court for the Northern District of California entitled
Securities and Exchange Commission v. Skoulis, Frankl et al.

Defending against the government investigation, the private securities class action, the
derivative actions and other litigation matters described above will likely continue to 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 government investigation and the
litigation matters described above to our directors and officers liability insurance carriers, the insurance carriers have raised certain coverage issues and to date have not reimbursed us for all legal expenses incurred, and may not agree 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 legal expenses and 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. Legal fees are expensed as incurred.



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|(9) | Segment, Geographic and Major Customer Information
|--- | --------------------------------------------------

Segment
Information:    The Company generates revenues from two primary groups, (i) broadband equipment and (ii) broadband software and services. Financial information regarding the operating segments was as follows:



|                               |  |                                    |  |                             |  |          |  |                    |  |                             |  |         
|------------------------------ |  | ---------------------------------- |  | --------------------------- |  | -------- |  | ------------------ |  | --------------------------- |  | --------
|                               |  | Three months ended June 30,       
|                               |  | 2006                               |  | 2005                       
|                               |  | Broadbandequipment                 |  | BroadbandSoftware &Services |  | Total    |  | Broadbandequipment |  | BroadbandSoftware &Services |  | Total   
|                               |  | (in thousands, except percentages)
|Revenues                       |  | $27,333                            |  | $3,154                      |  | $30,487  |  | $25,103            |  | $2,726                      |  | $27,829 
|Cost of revenues               |  | 19,142                             |  | 637                         |  | 19,779   |  | 18,943             |  | 501                         |  | 19,444  
|                               |  |                                    |  |                             |  |          |  |                    |  |                             |  |         
|Gross profit                   |  | 8,191                              |  | 2,517                       |  | 10,708   |  | 6,160              |  | 2,225                       |  | 8,385   
|Gross margin                   |  | 30%                                |  | 80%                         |  | 35%      |  | 25%                |  | 82%                         |  | 30%     
|Unallocated operating expenses |  |                                    |  |                             |  | 12,275   |  |                    |  |                             |  | 10,629  
|                               |  |                                    |  |                             |  |          |  |                    |  |                             |  |         
|Operating income (loss)        |  |                                    |  |                             |  | $(1,567) |  |                    |  |                             |  | $(2,244)
|                               |  |                                    |  |                             |  |          |  |                    |  |                             |  |         



|                               |  |                                    |  |                             |  |          |  |                    |  |                             |  |         
|------------------------------ |  | ---------------------------------- |  | --------------------------- |  | -------- |  | ------------------ |  | --------------------------- |  | --------
|                               |  | Nine months ended June 30,        
|                               |  | 2006                               |  | 2005                       
|                               |  | Broadbandequipment                 |  | BroadbandSoftware &Services |  | Total    |  | Broadbandequipment |  | BroadbandSoftware &Services |  | Total   
|                               |  | (in thousands, except percentages)
|Revenues                       |  | $71,099                            |  | $11,162                     |  | $82,261  |  | $73,547            |  | $8,823                      |  | $82,370 
|Cost of revenues               |  | 49,615                             |  | 1,770                       |  | 51,385   |  | 55,771             |  | 1,175                       |  | 56,946  
|                               |  |                                    |  |                             |  |          |  |                    |  |                             |  |         
|Gross profit                   |  | 21,484                             |  | 9,392                       |  | 30,876   |  | 17,776             |  | 7,648                       |  | 25,424  
|Gross margin                   |  | 30%                                |  | 84%                         |  | 38%      |  | 24%                |  | 87%                         |  | 31%     
|Unallocated operating expenses |  |                                    |  |                             |  | 34,675   |  |                    |  |                             |  | 31,400  
|                               |  |                                    |  |                             |  |          |  |                    |  |                             |  |         
|Operating loss                 |  |                                    |  |                             |  | $(3,799) |  |                    |  |                             |  | $(5,976)
|                               |  |                                    |  |                             |  |          |  |                    |  |                             |  |         

Geographic Information: The Company sells most of its products through its field sales organization, with a small
portion of sales through distributors and resellers. Most of the Companys sales are to telecommunication carriers and service providers in the United States and Europe through our field sales force. Our field sales force is geographically
disbursed within the United States and Europe and we have a sales office in Paris, France. Most of our sales in Europe are to customers in Switzerland and Ireland.

Sales outside of the United States are primarily export sales denominated in United States Dollars or Euros. Information regarding the Companys revenues by geographic region was as follows:



|                            |  |                                     |        |                            |      |      |   |        |  |      |  |   |        |  |      |  |   |        |  |     
|--------------------------- |  | ----------------------------------- | ------ | -------------------------- | ---- | ---- | - | ------ |  | ---- |  | - | ------ |  | ---- |  | - | ------ |  | ----
|                            |  | Three months ended June 30,         |        | Nine months ended June 30,
|                            |  | 2006                                |        | 2005                       |      | 2006 |   | 2005  
|                            |  | Region (in thousands and % revenue)
|Europe                      |  | $                                   | 13,211 |                            | 43%  |      | $ | 10,218 |  | 37%  |  | $ | 30,948 |  | 37%  |  | $ | 27,627 |  | 33% 
|Other international         |  |                                     | 715    |                            | 3%   |      |   | 535    |  | 2%   |  |   | 1,400  |  | 2%   |  |   | 2,155  |  | 3%  
|                            |  |                                     |        |                            |      |      |   |        |  |      |  |   |        |  |      |  |   |        |  |     
|Total international revenue |  |                                     | 13,926 |                            | 46%  |      |   | 10,753 |  | 39%  |  |   | 32,348 |  | 39%  |  |   | 29,782 |  | 36% 
|United States               |  |                                     | 16,561 |                            | 54%  |      |   | 17,076 |  | 61%  |  |   | 49,913 |  | 61%  |  |   | 52,588 |  | 64% 
|                            |  |                                     |        |                            |      |      |   |        |  |      |  |   |        |  |      |  |   |        |  |     
|Total revenues              |  | $                                   | 30,487 |                            | 100% |      | $ | 27,829 |  | 100% |  | $ | 82,261 |  | 100% |  | $ | 82,370 |  | 100%
|                            |  |                                     |        |                            |      |      |   |        |  |      |  |   |        |  |      |  |   |        |  |     

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

Customer Information:    The Companys largest customers are service providers. They include regional, national, and international
telecommunications carriers, as well as Internet Service Providers.

The following tables set forth customers and revenue amounts that were 10% or more of total
revenues reported for the period:



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|            |  |                              |       |                            |     |      |   |       |  |     |  |   |        |  |     |  |   |        |  |    
|----------- |  | ---------------------------- | ----- | -------------------------- | --- | ---- | - | ----- |  | --- |  | - | ------ |  | --- |  | - | ------ |  | ---
|            |  | Three months ended June 30,  |       | Nine months ended June 30,
|            |  | 2006                         |       | 2005                       |     | 2006 |   | 2005 
|            |  | (in thousands and % revenue)
|            |  |                              |       |                            |     |      |   |      
|BellSouth   |  | $                            | 5,902 |                            | 19% |      | $ | 5,798 |  | 21% |  | $ | 17,121 |  | 21% |  | $ | 16,918 |  | 21%
|Swisscom AG |  |                              | 5,409 |                            | 18% |      |   | 6,372 |  | 23% |  |   | 15,413 |  | 19% |  |   | 14,218 |  | 17%
|eircom Ltd. |  |                              | 3,808 |                            | 12% |      |   | 3,089 |  | 11% |  |   | 9,293  |  | 11% |  |   | 8,403  |  | 10%

The following tables set forth customer balances that were 10% or more of accounts receivable and the percentage of total
accounts receivable:



|            |  |                                         |  |    
|----------- |  | --------------------------------------- |  | ---
|            |  | June 30, 2006                          
|            |  | (in thousands and% accounts receivable)
|Swisscom AG |  | $3,441                                  |  | 20%
|eircom Ltd  |  | $2,827                                  |  | 17%
|BellSouth   |  | $2,056                                  |  | 12%
|            | 
|            |  | September 30, 2005                     
|            |  | (in thousands and% accounts receivable)
|            |  |                                        
|Swisscom AG |  | $3,326                                  |  | 21%
|BellSouth   |  | $2,612                                  |  | 16%
|eircom Ltd. |  | $1,682                                  |  | 10%



|(10) | Credit Facility
|---- | ---------------

Under the Companys amended credit facility agreement with
Silicon Valley Bank, the credit limit is $10 million, the interest rate is Silicon Valley Banks prime rate, and the term or maturity date is June 27, 2007. The amended credit facility contains financial covenants related to liquidity and
net worth as well as other nonfinancial covenants. Covenants require that the Company maintain an adjusted quick ratio (described below) of 1.25 and the credit facility will be subject to formula based credit limits if the adjusted quick ratio falls
below 1.50. Covenants also required the Company to maintain a minimum tangible net worth of $28 million at September 30, 2005; subsequently the minimum tangible net worth declines every few months to $24 million at June 30, 2006 and
thereafter, unless reset. The facility is secured by substantially all of the assets of the Company. The adjusted quick ratio is the ratio of (i) the Companys unrestricted cash, cash equivalents and investments maintained at
Silicon Valley Bank plus net receivables to (ii) the Companys current liabilities plus the outstanding principal amount of any borrowings under the facility less deferred revenues. 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, 2006, the Company was in compliance with the covenants, had access to
approximately $8.9 million of the credit facility and had no outstanding borrowings. The Company has approximately $800,000 of outstanding letters of credit and $300,000 of cash management reserves that reduce the amount of available credit on the
credit facility to $8.9 million.

During the quarter ended June 30, 2006, the Company entered into an agreement with a wireless telecommunications service
provider in Germany which requires the delivery of a NBBS solution for the remote management of customer premises equipment with a contractual period from 2006 through 2010. The agreement includes the delivery of network equipment and services.
Under the terms of the agreement, the Company is required to issue a performance bond as a guarantee that the Company will fulfill its contractual obligations. During the quarter ended June 30, 2006, the Company issued a performance bond in the
form of an irrevocable standby letter of credit. The expiration date of the letter of credit is June 29, 2007. The letter of credit shall be automatically renewed without amendment for a period of one year from the expiration date or any
automatically extended expiration date not later than June 30, 2012. This letter of credit is secured by the Companys credit facility.



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In the event the Companys customer in Germany claims that the Company has not fulfilled all contractual obligations, the
customer may submit a claim in writing to the German bank that issued the letter of credit. During the period that the letter of credit is effective, any claim would result in a payment of cash to the customer up to a maximum of 500,000 Euros.
This letter of credit is included in the $1.1 million reserved against the Companys credit facility as of June 30, 2006.

As of June 30, 2006, the
Company was not aware of any claims submitted (written or verbal) by the Companys German customer that would require the accrual of a liability under GAAP. As such, and in accordance with GAAP, the Company has not accrued any liability
associated with the issuance of the letter of credit in the Condensed Consolidated Balance Sheet as of June 30, 2006.



|(11) | Gain On Equity Investment
|---- | -------------------------

During quarter ended June 30, 2006, the Company sold
its equity investment in MegaPath Inc. in exchange for $734,000 cash and 1.7 million shares of Series 2 preferred stock of Netifice Communications, Inc (Netifice). In accordance with the criteria of SFAS 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities  a replacement of FASB Statement 125, the Company accounted for the transaction as a transfer of an asset that qualified as a sale. Accordingly, the Company removed its
investment in MegaPath Inc. and recognized the cash received and its investment in Netifice at fair value, which resulted in a gain of $1.1 million in the Condensed Consolidated Statement of Operations.



|(12) | Other Income (Expenses), Net
|---- | ----------------------------

Other income, net, primarily consisted of interest
income earned on cash and cash equivalents, interest expense related to the credit facility and realized and unrealized gains and losses on foreign currency transactions. The following table summarizes the Companys other income, net:



|                                   |  |                            |     |   |                           |   |      |      |  |   |      |   |  |   |     |  
|---------------------------------- |  | -------------------------- | --- | - | ------------------------- | - | ---- | ---- |  | - | ---- | - |  | - | --- | -
|                                   |  | Three Months EndedJune 30, |     |   | Nine Months EndedJune 30, |  
|                                   |  | 2006                       |     |   | 2005                      |   |      | 2006 |  |   | 2005 |  
|                                   |  | (in thousands)             |    
|                                   |  |                            |     |  
|Interest income                    |  | $                          | 249 |   |                           | $ | 137  |      |  | $ | 678  |   |  | $ | 338 |  
|Interest expense                   |  |                            | (11 | ) |                           |   | (10  | )    |  |   | (32  | ) |  |   | (23 | )
|Other income (expense)             |  |                            | 106 |   |                           |   | (171 | )    |  |   | 57   |   |  |   | (56 | )
|                                   |  |                            |     |   |                           |   |      |      |  |   |      |   |  |   |     |  
|Total other income (expenses), net |  | $                          | 344 |   |                           | $ | (44  | )    |  | $ | 703  |   |  | $ | 259 |  
|                                   |  |                            |     |   |                           |   |      |      |  |   |      |   |  |   |     |  



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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

Netopia, Inc. (the Company) is a developer and provider of
high performance broadband customer premises networking equipment and carrier-class software for the remote management of broadband services and equipment. The Company also develops and provides broadband enabled services and remote management
software for enterprises technical support, help-desks and personal computers.

Our broadband equipment includes modems, routers and gateways, and related
accessories for use at the premises. Our equipment enables advance high-speed broadband access and services. DSL technologies and standards used to transmit data over copper lines, including integrated wireless (or Wi-Fi) access, are a technology
focus for our equipment. The largest customers for our equipment are telecommunications carriers. These customers deploy our equipment at their broadband customers premises, including residences and distributed businesses.

Our management software enables carriers to remotely manage our gateways, as well as gateways from third party suppliers, and to deploy new broadband services. Our software
enables broadband service providers and enterprises to remotely respond to service problems and calls and to automate the maintenance of the gateways and broadband services. Our solution also provides for the efficient delivery of value added
services. NBBS, or Netopia Broadband Server, is the brand name for our remote management software, which we license on both a server license and hosted basis.

We
also license and host software for remotely managing networks of personal computers. This software is licensed under the brand names Timbuktu and eCare. eCare is a solution designed for enterprise technical service support and help desks. Our
solutions enable remote problem solving and management of distributed desktop or personal computers.

We sell Web site services, including Web site hosting,
development, and tools for Web site development. We offer a Hot-Spot solution and service for distributed enterprises, such as restaurants, hotels and other venues that offer wireless Internet access to their customers. We offer a Parental Controls
service that provides content filtering and other controls over access to the Internet.

Our broadband equipment is manufactured by outsourced manufacturers in
Thailand, China and Mexico. The components included in our equipment are high-quality industry standard components provided by leading vendors. We work closely with the providers of silicon chips, circuits and switches, antennae and other
high-technology components in the development of our products. We develop and maintain the embedded software called firmware included in our equipment.



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The markets in which we compete are highly competitive. We continuously strive to make advances and compete based on
forward-looking technology and service innovations, superior performance and quality, and by identifying solutions and opportunities for our customers to attract and retain customers, improve productivity, reduce costs, and achieve competitive
advantage.

Overview of Operating Results

We are focusing on revenue
growth for both our broadband networking equipment and our software and services. Our objective is to increase sales to existing customers and to attract new customers. Our strategy is to leverage our strengths in DSL technologies and remote
management to meet market requirements for higher bandwidth services, including IPTV (Internet Protocol Television), being provided by telecommunications and Internet service providers. This focus includes achieving design wins and customer field
trials for increasingly higher performance gateways and remote management software utilizing new technologies and standards, including VDSL2 and ADSL2+ Bonded technologies as well as other innovations. Our VDSL2 and ADSL2+ Bonded products are in
numerous evaluations around the world. If we succeed through the customer field trial phase, we believe that we than have the opportunity for high volume equipment sales to that customer. Software and services revenue growth is largely dependent on
service providers deploying new standards in DSL remote management and being selected by customers for their deployments.

We believe that we made progress toward
our 2006 revenue growth goals during the first nine months of our fiscal year ending September 30, 2006. This progress includes increased sales of both our NBBS remote management software and broadband equipment.

In the first nine months of our fiscal year, we completed three and signed an agreement for a fourth transaction for our NBBS remote management software. The three completed
transactions were closed in our second quarter ended March 31, 2006. The most significant of the three completed transactions was an NBBS software license to BellSouth. The three completed software transactions were the cause of the increase in
our software and services revenue and were a significant contribution to our net results in the first nine months of our fiscal year. In our third quarter ended June 30, 2006, we signed an agreement for the deployment of our NBBS remote
management software to a wireless telecommunications service provider in Germany. Initial billings related to this agreement were recorded as deferred revenue in the quarter ended June 30, 2006. This agreement includes services and the ability
to expand the scope of use of the software upon payment of additional incremental license fees. Over the next four year period, the revenue related to this agreement has the potential to total several million dollars, depending on level of
incremental license fees. We have added sales and professional service resources for the sale and deployment of NBBS remote management software and have an active pipeline of opportunities.

We achieved a number of broadband equipment growth milestones.



| |  |  | We successfully completed a field trial with a new European customer in Denmark for our ADSL2+ Wi-Fi equipment and recorded $2.1 million of equipment revenue in our third quarter ended
June 30, 2006. We have approximately $900,000 of deferred revenue related to this customer as of June 30, 2006 and we expect to recognize this as revenue in our fourth quarter ending September 30, 2006.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We recognized our first $1 million of revenue in our third quarter ended June 30, 2006, for VDSL2 equipment sold to Alcatel for an IPTV roll out in Switzerland. We believe that our
progress to date with VDSL2 equipment in Switzerland has helped our products to be more broadly considered by other new customers, particularly in Europe. Our equipment is undergoing lab evaluation by a number of prospective new customers. While
these lab evaluations provide opportunities for sales growth for our broadband equipment, we do not expect to receive any potential volume orders before calendar year 2007. The receipt of orders is contingent on the successful completion of field
trials as well as other factors.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | We have begun to receive orders to ship residential-class modems to BellSouth, and we expect to recognize initial revenue related to such shipments in the fourth fiscal quarter ending
September 30, 2006.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We expect that both our broadband equipment and software and services revenues will be relatively flat in the fourth fiscal
quarter ending September 30, 2006, as compared with the third fiscal quarter ended June 30, 2006.

Overall gross margin rates for the first nine months of
fiscal year 2006 improved 6.6 percentage points to 37.5%, from 30.9% for the first nine months of the prior fiscal year. Improvements in our equipment gross margins contributed to most of this improvement. Equipment gross margins improved 6.0
percentage points to 30.2% for the first nine months of fiscal year 2006 from 24.2% for the first nine months of the prior fiscal year. This improvement mostly reflected the benefit of cost reductions, and secondarily from a greater mix of Wi-Fi
broadband equipment sales and a greater mix of business-class broadband equipment sales. In addition, the increase in the higher margin software and services revenue contributed to the gross margin rate improvement. Software and services revenue
increased $2.3 million in the first nine months of fiscal year 2006, compared with the same period of the prior fiscal year. Most of this increase was from our second fiscal quarter ended March 31, 2006, which included license revenues for our
NBBS remote management software to BellSouth. We expect that our overall gross margin will be relatively flat sequentially in the fourth fiscal quarter ending September 30, 2006, as compared with the third fiscal quarter ended June 30,
2006. Looking beyond the fourth fiscal quarter, gross margin rates are expected to be volatile because of fluctuations in the mix of revenues from equipment and software and services. For example, the gross margin is expected to be higher in periods
that we achieve a higher mix of software and services revenues, such as in the second quarter of fiscal year 2006 when we recognized the revenue from the license of our NBBS remote management software to BellSouth. In addition, we expect broadband
equipment revenues to grow, in part, from sales of residential-class broadband equipment, which carry a lower gross margin rate than sales of business-class broadband equipment, which could cause a decline in the gross margin rate.

We began to include stock compensation expense in our Statement of Operations as of the beginning of fiscal year 2006 and this caused an increase in operating expenses on a
year-over-year basis. In the first nine months of fiscal year ended September 30 2006, we recorded $4.0 million of stock compensation expense. Stock compensation expenses will impact future quarters with similar levels of expenses and will
impact the year-over-year comparison of our fiscal year 2006 to fiscal year 2005. We continue to grant stock options to employees in an effort to align employee interests with the interests of shareholders as well as to attract and retain key
employees. Excluding the impact of stock compensation expense, our research and development and sales and marketing expenses have both trended upward. This trend reflects increased hiring, hiring costs, compensation expenses, and travel costs.
During the third quarter ended June 30, 2006, we hired more engineers, sales people, and contractors for the deployment of our NBBS remote management software. We believe that this hiring puts us in a better position to grow our revenue from
NBBS remote management software. General and administrative expenses have experienced volatility from both legal costs and audit cycles. While both legal costs and audit costs have trended lower in first nine months of fiscal year 2006, compared
with the corresponding period of the prior year, both of these expenses continue to be volatile. Legal costs were lower in the first nine months of fiscal year 2006 compared with the first nine months of fiscal year 2005, in part, because of
insurance reimbursements of legal costs.

In the first quarter ended December 31, 2006, we recorded a $300,000 charge to general and administrative expenses
related to settlement of a bankruptcy preference claim related to a customer that went bankrupt and ceased operations several years ago. In the third quarter ended June 30, 2006, we recorded a $1.1 million gain on the sale of our equity
interest in MegaPath Inc. to Netifice Communications, Inc. For our equity interest, we received cash of $734,000 and Netifice preferred stock, which was recorded at the fair value of $1,377,000.

Beginning in fiscal year 2006, we adopted SFAS 123(R) on a modified prospective basis. The following table summarizes the classification of stock-based compensation expense
related to employee stock



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options and employee stock purchases under SFAS 123(R) for the three and nine months ended June 30, 2006:



|                                                                |  |                                 |       |                                |   |      
|--------------------------------------------------------------- |  | ------------------------------- | ----- | ------------------------------ | - | -----
|                                                                |  | Three Months EndedJune 30, 2006 |       | Nine Months EndedJune 30, 2006
|                                                                |  | (in thousands)                 
|Stock-based compensation expense was included in:               |  |                                 |       |                                |   |      
|                                                                |  |                                
|Cost of revenues  broadband equipment                          |  | $                               | 72    |                                | $ | 140  
|                                                                |  |                                 |       |                                |   |      
|Research and development                                        |  |                                 | 590   |                                |   | 1,549
|                                                                |  |                                
|Selling and marketing                                           |  |                                 | 353   |                                |   | 834  
|                                                                |  |                                
|General and administrative                                      |  |                                 | 428   |                                |   | 1,462
|                                                                |  |                                 |       |                                |   |      
|Stock-based compensation expense included in operating expenses |  |                                 | 1,371 |                                |   | 3,845
|                                                                |  |                                 |       |                                |   |      
|                                                                |  |                                
|Stock-based compensation expense included in net loss           |  | $                               | 1,443 |                                | $ | 3,985
|                                                                |  |                                 |       |                                |   |      

The table below reflects basic and diluted net loss per share for the three and nine months ended June 30, 2006
compared with the pro forma information for the three and nine months ended June 30, 2005:



|                                                                                                |  |                            |       |   |                           |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------------------------------------------------------------------- |  | -------------------------- | ----- | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                |  | Three Months EndedJune 30, |       |   | Nine Months EndedJune 30, |  
|                                                                                                |  | 2006                       |       |   | 2005                      |   |        | 2006 |  |   | 2005   |  
|                                                                                                |  | (in thousands)             |      
|Net loss - as reported for the prior period                                                     |  |                            | N/A   |   |                           | $ | (2,312 | )    |  |   | N/A    |   |  | $ | (5,785 | )
|Stock-based compensation expense related to employee stock options and employee stock purchases |  | $                          | 1,443 |   |                           | $ | 1,152  |      |  | $ | 3,985  |   |  | $ | 3,735  |  
|                                                                                                |  |                            |       |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net loss - including the effect of stock-based compensation expense                             |  | $                          | (156  | ) |                           | $ | (3,464 | )    |  | $ | (2,054 | ) |  | $ | (9,520 | )
|                                                                                                |  |                            |       |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted loss per share  as reported for the prior period                             |  |                            | N/A   |   |                           | $ | (0.09  | )    |  |   | N/A    |   |  | $ | (0.25  | )
|                                                                                                |  |                            |       |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted loss per share - including the effect of stock-based compensation             |  | $                          | (0.01 | ) |                           | $ | (0.14  | )    |  | $ | (0.08  | ) |  | $ | (0.38  | )
|                                                                                                |  |                            |       |   |                           |   |        |      |  |   |        |   |  |   |        |  



| | (1) | Net loss and net loss per share prior to fiscal year 2006 did not include stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123
because we did not adopt the recognition provisions of SFAS 123.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (2) | Stock-based compensation expense prior to fiscal year 2006 is calculated based on the pro forma application of SFAS 123 as previously disclosed in the notes to the Consolidated Financial
Statements.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (3) | Net loss and net loss per shares prior to fiscal year 2006 represents pro forma information based on SFAS 123 as previously disclosed in the notes to the Consolidated Financial Statements.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our net loss for the three and nine months ended June 30, 2006 was a loss of $156,000 and $2.1 million. Stock compensation costs were $1.4
million and $4.0 million for the three and nine months ended June 30, 2006. The amortization of acquisition-related intangibles were $300,000 and $900,000 in the three and nine months ended June 30, 2006. The net results in the nine months
ended June 30, 2006 reflected the benefit of increased software and services revenue and increased gross margins. Our net results in future periods will depend on our ability to grow our equipment revenues and to complete software and services
transactions, particularly those involving our NBBS remote management software. The trend in our net results may be volatile from quarter to quarter.

We utilize
non-GAAP measures in the management of our business. When we evaluate our core operating performance trends and potential to generate cash in the future, we use non-GAAP measures that exclude a number of items, including non-cash stock compensation,
non-cash amortization of



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acquisition-related intangibles, settlements, and equity investment gains. While we find it helpful to exclude certain items in evaluating trends and our potential to
generate cash, we believe that financial measures based on GAAP are the best overall measure of our operating performance and non-GAAP measures are not intended to be a substitute for GAAP measures.

Cash of $26.5 million as of June 30, 2006, increased from $22.2 million as of September 30, 2005. We continue to have no long-term debt and a $10 million credit line
with approximately $8.9 million available for borrowings.

Critical Accounting Policies and Estimates

Managements discussion and analysis of our financial condition and results of operations are based upon our Condensed 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 Condensed Consolidated 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 the allowance for
doubtful accounts, sales reserves, inventory write-downs, customer support service accruals, warranty obligations, depreciation and amortization, contingencies and potential impairment of investments, intangible assets, goodwill and other assets. We
base our 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. Management on an ongoing basis reviews these estimates and judgments. The Audit Committee of our
Board of Directors 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.

You should read our Annual Report on Form 10-K for the fiscal year ended September 30, 2005 for information pertaining to our critical accounting policies, which include the
following:

| |  |  | Revenue recognition;
| | - |  | --------------------

| |  |  | Goodwill;
| | - |  | ---------

| |  |  | Impairment evaluation on long-lives assets, including other intangible assets;
| | - |  | ------------------------------------------------------------------------------

| |  |  | Allowance for doubtful accounts;
| | - |  | --------------------------------

| |  |  | Allowance for sales returns;
| | - |  | ----------------------------

| |  |  | Service accrual;
| | - |  | ----------------

| |  |  | Product warranty; and
| | - |  | ---------------------

| |  |  | Excess and obsolete 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, 2006, our
principal sources of liquidity included cash and cash equivalents in the amount of $26.5 million and a credit facility, which has a credit limit of $10 million. We had no outstanding borrowings against our credit facility at June 30, 2006, and
approximately $1.1 million of the credit facility is used for credit purposes, including letters of credit and reserves for cash management services.

During the
quarter ended June 30, 2006, the Company entered into an agreement with a wireless telecommunications service provider in Germany which requires the delivery of a NBBS solution for the remote management of customer premises equipment with a
contractual period from 2006 through 2010. The agreement includes the delivery of network equipment and services. Under the terms of the agreement, the Company is required to issue a performance bond as a guarantee that the Company will fulfill its
contractual obligations. During the quarter ended June 30, 2006, the Company issued a performance bond in the form of an irrevocable standby letter of credit. The expiration date of this letter of credit is June 29, 2007. The letter of
credit shall be automatically renewed without amendment for a period of one year from the expiration date or any automatically extended expiration date not later than



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June 30, 2012. The letter of credit is secured by the Companys credit facility. In the event the Companys customer in Germany claims that the Company
has not fulfilled all contractual obligations, this customer may submit a claim in writing to the German bank that issued the letter of credit. During the period that the letter of credit is effective, any claim would result in a payment of
cash to the customer up to a maximum of 500,000 Euros. This letter of credit is included in the $1.1 million reserved against the Companys credit facility as of June 30, 2006.

In addition, our liquidity benefits from our practice of purchasing most of our inventory from outsourced manufacturers. Our outsourced manufacturers utilize their financial resources to procure raw materials and maintain
facilities to manufacture products based on purchase orders received from us. We believe our cash and cash equivalents and cash expected to be generated by our business activities will be sufficient to meet our working capital needs for at least the
next twelve months.

Cash and Cash Equivalents



|                          |  |                                  |  |               |  |          |       |   |    
|------------------------- |  | -------------------------------- |  | ------------- |  | -------- | ----- | - | ---
|                          |  | June 30,                         |  | September 30, |  | Increase
|                          |  | 2006                             |  | 2005          |  | $        |       | %
|                          |  | (in thousands except percentage)
|Cash and cash equivalents |  | $26,547                          |  | $22,234       |  | $        | 4,313 |   | 19%
|                          |  |                                  |  |               |  |          |       |   |    

For the nine months ended June 30, 2006, cash and cash equivalents increased primarily as a result of cash provided by
operating activities and the proceeds from the issuance of common stock. We did not have any off-balance sheet transactions at June 30, 2006 or September 30, 2005.

Net Cash Provided by Operating Activities

Net cash provided by operating activities totaled $3.1 million for the nine months ended June 30,
2006, compared to a use of $1.2 million for the nine months ended June 30, 2005. Excluding the changes in operating assets and liabilities, our operating activities provided $2.6 million of cash for the nine months ended June 30, 2006.
This reflects that depreciation, amortization, non-cash charges for stock-based compensation all of which were offset by a gain on the sale of our equity investment still exceeded our net loss. Changes in our operating assets and liabilities
provided $520,000 of cash primarily as a result of a decrease in inventory and increases in deferred revenue and other current liabilities, which were offset by increases in accounts receivable, prepaid expenses and other assets, and a decrease to
accounts payable. These changes in operating assets and liabilities reflected the initial invoice to a major NBBS contract with a large German wireless carrier. These changes were recorded in inventory, accounts receivable and deferred revenue with
deferred costs recorded in other current assets, as of June 30, 2006. Cash used or provided by inventory and accounts payable tend to fluctuate from period to period with the timing of inventory purchases and payments.

Net Cash Provided by Investing Activities

Net cash provided by investing activities
totaled $170,000 for the nine months ended June 30, 2006, compared to $1.2 million cash used for the nine months ended June 30, 2005. Investing activities consisted of the sale of an equity investment offset by purchases of capital
equipment, including manufacturing tooling and information technology equipment.

Net Cash Provided by Financing Activities

Net cash provided from financing activities totaled $978,000 for the nine months ended June 30, 2006, compared to $1.2 million for the nine months ended June 30, 2005.
For the nine months ended June 30, 2006, financing activities consisted of the issuance of common stock pursuant to the ESPP and from the exercise of stock options. For the nine months ended June 30, 2005, financing activities consisted of
the issuance of common stock pursuant to the ESPP and from the exercise of stock options, offset by $104,000 of repayments of term loans.



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Commitments

Operating Lease
Commitments.    The Company conducts its operations in leased facilities under operating lease agreements expiring at various dates through 2014. The following is a summary of future minimum rental payments required under
these leases that have initial or remaining non-cancelable lease terms in excess of one year (the 2006 amount is for the three months remaining in the fiscal year):



|                           |  |                           |     |      |   |       |  |      |       |      |   |            |  |       |     |  |          |  |   |      
|-------------------------- |  | ------------------------- | --- | ---- | - | ----- |  | ---- | ----- | ---- | - | ---------- |  | ----- | --- |  | -------- |  | - | -----
|                           |  | Year ending September 30,
|                           |  | 2006                      |     | 2007 |   | 2008  |  | 2009 |       | 2010 |   | Thereafter |  | Total
|                           |  | (in thousands)           
|Property lease obligations |  | $                         | 337 |      | $ | 1,371 |  | $    | 1,076 |      | $ | 466        |  | $     | 335 |  | $    110 |  | $ | 3,695
|                           |  |                           |     |      |   |       |  |      |       |      |   |            |  |       |     |  |          |  |   |      

Purchase Commitments with Outsourcing Manufacturers and Suppliers.    The Company has purchase
commitments with its outsourcing manufacturers. Our outsourcing manufacturers procure component inventory on our behalf based on our production orders. The Company is obligated to purchase component inventory that the outsourcing manufacturer
procures in accordance with the orders, unless cancellation is given within applicable lead times. These commitments are reflected in our financial statements as a liability once goods or services have been received by us or payments related to the
obligations become due. At June 30, 2006, purchase commitments totaled $21.2 million.

Foreign Currency Derivatives.    The Company
has entered into foreign currency forward contracts to hedge foreign currency denominated receivables. Forward contracts involve agreements to sell foreign currency at specified rates at future dates. The following table presents the value of
currency exchange forward contracts, in United States dollars, at June 30, 2006 and September 30, 2005.



|                                              |  |                                                       |  |                       |  |                   |  |        |  |                       |  |               
|--------------------------------------------- |  | ----------------------------------------------------- |  | --------------------- |  | ----------------- |  | ------ |  | --------------------- |  | --------------
|                                              |  | June 30, 2006                                         |  | September 30, 2005   
|                                              |  | Amount                                                |  | ContractedForwardRate |  | SettlementDate(s) |  | Amount |  | ContractedForwardRate |  | SettlementDate
|                                              |  | (Amount in thousands, except contracted forward rate)
|Principal (notional) amounts in U.S. dollars: |  |                                                       |  |                       |  |                   |  |        |  |                       |  |               
|Euro forward exchange contract                |  | $278                                                  |  | $1.245                |  | Jul-2006          |  | $2,148 |  | $1.212                |  | Oct-2005      
|                                              |  |                                                       |  |                       |  |                  
|Euro forward exchange contract                |  | 1,076                                                 |  | 1.273                 |  | Jul-2006          |  |        |  |                       |  |               
|                                              |  |                                                       |  |                       |  |                  
|Euro forward exchange contract                |  | 1,423                                                 |  | 1.271                 |  | Aug-2006          |  |        |  |                       |  |               
|                                              |  |                                                       |  |                       |  |                  
|Euro forward exchange contract                |  | 991                                                   |  | 1.271                 |  | Sep-2006          |  |        |  |                       |  |               
|                                              |  |                                                       |  |                       |  |                  
|Swiss franc forward exchange contract         |  | 232                                                   |  | 0.816                 |  | Aug-2006          |  |        |  |                       |  |               
|                                              |  |                                                       |  |                       |  |                  
|Swiss franc forward exchange contract         |  | 800                                                   |  | 0.814                 |  | Aug-2006          |  |        |  |                       |  |               
|                                              |  |                                                       |  |                       |  |                   |  |        |  |                       |  |               
|                                              |  |                                                       |  |                       |  |                  
|                                              |  | $4,800                                                |  |                       |  |                   |  | $2,148 |  |                       |  |               



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Results of Operations for the Three Months and Nine Months Ended June 30, 2006 and 2005

This data has been derived from the Statements of Operations elsewhere in this Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2005.
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 Financial Statements and Notes thereto included elsewhere in this Form 10-Q and in the
Annual Report on Form 10-K for the fiscal year ended September 30, 2005.

REVENUES



|                               |  |                                     |        |        |      |  |   |        |  |      |  |      
|------------------------------ |  | ----------------------------------- | ------ | ------ | ---- |  | - | ------ |  | ---- |  | -----
|                               |  | Three Months Ended June 30,         |        | Change
|                               |  | 2006                                |        | 2005   |     
|                               |  | (in thousands & percent of revenue) |        |       
|Broadband equipment            |  | $                                   | 27,333 |        | 90%  |  | $ | 25,103 |  | 90%  |  | 9%   
|Broadband software and service |  |                                     | 3,154  |        | 10%  |  |   | 2,726  |  | 10%  |  | 16%  
|                               |  |                                     |        |        |      |  |   |        |  |      |  |      
|Total revenues                 |  | $                                   | 30,487 |        | 100% |  | $ | 27,829 |  | 100% |  | 10%  
|                               |  |                                     |        |        |      |  |   |        |  |      |  |      
|                               |  |                                    
|                               |  | Nine Months Ended June 30,          |        | Change
|                               |  | 2006                                |        | 2005   |     
|                               |  | (in thousands & percent of revenue) |        |       
|Broadband equipment            |  | $                                   | 71,099 |        | 86%  |  | $ | 73,547 |  | 89%  |  | -3%  
|Broadband software and service |  |                                     | 11,162 |        | 14%  |  |   | 8,823  |  | 11%  |  | 27%  
|                               |  |                                     |        |        |      |  |   |        |  |      |  |      
|Total revenues                 |  | $                                   | 82,261 |        | 100% |  | $ | 82,370 |  | 100% |  | -0.1%
|                               |  |                                     |        |        |      |  |   |        |  |      |  |      

An increase in broadband equipment revenue was the primary cause of the 10% increase in total revenues for the three months
ended June 30, 2006, compared with the same period of the prior year.

For the nine months ended June 30, 2006, the decrease in broadband equipment revenue
was mostly offset by an increase in software and services revenue, and the net effect was relatively flat revenues for the comparative nine month periods.

Broadband Equipment.    An increase in broadband equipment units shipped was the primary reason for the increase in broadband equipment revenue for the three months ended June 30, 2006, compared
with the same period of the prior year. Contributing to the increase in units shipped, we recognized revenue on $2.1 million of ADSL2+ Wi-Fi equipment sold to a new customer in Denmark.

The first quarter of 2005 was the last quarter that we had sales to BellSouth for its wholesale customers and that caused the decline in broadband equipment revenue for the nine months ended June 30, 2006, compared with
the same period of the prior year.

The table below includes broadband equipment unit sales volumes and average selling prices. The amounts exclude accessories unit
volumes and revenue from the calculation of average selling prices.



|                             |  |                            |  |                           |  |         |  |        
|---------------------------- |  | -------------------------- |  | ------------------------- |  | ------- |  | -------
|                             |  | Three Months EndedJune 30, |  | Nine Months EndedJune 30,
|                             |  | 2006                       |  | 2005                      |  | 2006    |  | 2005   
|Equipment unit sales volumes |  | 320,000                    |  | 276,000                   |  | 833,000 |  | 830,000
|Average selling prices       |  | $81                        |  | $83                       |  | $81     |  | $83    

We expect that broadband equipment revenue will sequentially be relatively flat in the fourth fiscal quarter ending
September 30, 2006 as compared with the third fiscal quarter ended June 30, 2006.

Broadband Software and
Services.    In the third fiscal quarter ended June 30, 2006, the increase in software and services revenue was attributable to increases in maintenance revenue related to NBBS remote management software and
other services which were partially offset by decreases in license sales of our system management software, Timbuktu and netOctopus Enterprise.



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GROSS MARGIN



|                               |  |                                     |        |                        |     |  |   |        |  |     |  |    
|------------------------------ |  | ----------------------------------- | ------ | ---------------------- | --- |  | - | ------ |  | --- |  | ---
|                               |  | Three Months Ended June 30,         |        | Percentage PointChange
|                               |  | 2006                                |        | 2005                   |    
|                               |  | (in thousands & percent of revenue) |        |                       
|Broadband equipment            |  | $                                   | 8,191  |                        | 30% |  | $ | 6,160  |  | 25% |  | 5% 
|Broadband software and service |  |                                     | 2,517  |                        | 80% |  |   | 2,225  |  | 82% |  | -2%
|                               |  |                                     |        |                        |     |  |   |        |  |     |  |    
|Total gross margin             |  | $                                   | 10,708 |                        | 35% |  | $ | 8,385  |  | 30% |  | 5% 
|                               |  |                                     |        |                        |     |  |   |        |  |     |  |    
|Broadband equipment            |  | $                                   | 21,484 |                        | 30% |  | $ | 17,776 |  | 24% |  | 6% 
|                               |  |                                    
|                               |  | Nine Months Ended June 30,          |        | Percentage PointChange
|                               |  | 2006                                |        | 2005                   |    
|                               |  | (in thousands & percent of revenue) |        |                       
|Broadband software and service |  |                                     | 9,392  |                        | 84% |  |   | 7,648  |  | 87% |  | -3%
|                               |  |                                     |        |                        |     |  |   |        |  |     |  |    
|Total gross margin             |  | $                                   | 30,876 |                        | 38% |  | $ | 25,424 |  | 31% |  | 7% 
|                               |  |                                     |        |                        |     |  |   |        |  |     |  |    

The total amount of gross profit and the overall gross margin percentage rate improved in the three and nine months ended
June 30, 2006, compared with the same periods of the prior fiscal year because of increased broadband equipment revenues at improved gross margins.

Broadband Equipment.    The improvement in the gross margin rate earned on sales of broadband equipment mostly reflected the benefit of cost reductions, and secondarily a greater mix of Wi-Fi and
business-class broadband equipment sales. Sales of business-class and Wi-Fi broadband equipment tend to earn a higher gross margin rate than sales of residential-class broadband equipment. We believe that the residential-class broadband equipment
market is larger than the business-class broadband equipment market, and we are seeking to increase our sales of residential-class broadband equipment. If we are successful in increasing our sales of residential-class broadband equipment, our
broadband equipment gross margin rates may decline because sales of this class of equipment tends to earn a lower gross margin rate than sales of business-class broadband equipment. In seeking to increase sales of residential-class broadband
equipment, our goal is to increase the total amount of broadband equipment gross profit.

Broadband Software and
Services.    Higher costs related to web site development for our customers caused a decrease in the amount of gross margin earned on software and services.

RESEARCH AND DEVELOPMENT



|                         |  |                                     |  |        |  |         |  |     |  |    
|------------------------ |  | ----------------------------------- |  | ------ |  | ------- |  | --- |  | ---
|                         |  | Three Months Ended June 30,         |  | Change
|                         |  | 2006                                |  | 2005   | 
|                         |  | (in thousands & percent of revenue) |  |       
|                         |  |                                     |  |        | 
|Research and development |  | $4,505                              |  | 15%    |  | $3,400  |  | 12% |  | 33%
|                         |  |                                     |  |        |  |         |  |     |  |    
|                         |  |                                    
|                         |  | Nine Months Ended June 30,          |  | Change
|                         |  | 2006                                |  | 2005   | 
|                         |  | (in thousands & percent of revenue) |  |       
|                         |  |                                     |  |        | 
|Research and development |  | $12,616                             |  | 15%    |  | $10,009 |  | 12% |  | 26%
|                         |  |                                     |  |        |  |         |  |     |  |    

Research and development (R&D) expenses consist primarily of employee related expenses, depreciation and
amortization, development related expenses such as product prototyping, design and testing, and overhead.

Stock based compensation expense was 17 and 15 percentage
points, respectively of the 33% and 26% increases in R&D expense in the three and nine months ended June 30, 2005. The remaining increase in R&D expense reflected an increase in the R&D headcount and salaries. For the three and nine
months ended June 30, 2006, $590,000 and $1,549,000 of R&D expense, respectively, was non-cash stock-based compensation expense recorded pursuant to the October 1, 2005 prospective adoption of SFAS



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123(R). This amounted to 2% of revenue for the three and nine months ended June 30, 2006, respectively.

We expect to continue to allocate substantial resources to product and technological development as a percentage of revenue, and R&D expenses may increase in the future.

SELLING AND MARKETING



|                      |  |                                     |        |        |     |  |   |        |  |     |  |    
|--------------------- |  | ----------------------------------- | ------ | ------ | --- |  | - | ------ |  | --- |  | ---
|                      |  | Three Months Ended June 30,         |        | Change
|                      |  | 2006                                |        | 2005   |    
|                      |  | (in thousands & percent of revenue) |        |       
|Selling and marketing |  | $                                   | 5,502  |        | 18% |  | $ | 4,582  |  | 16% |  | 20%
|                      |  |                                     |        |        |     |  |   |        |  |     |  |    
|                      |  |                                    
|                      |  | Nine Months Ended June 30,          |        | Change
|                      |  | 2006                                |        | 2005   |    
|                      |  | (in thousands & percent of revenue) |        |       
|                      |  |                                     |        |        |    
|Selling and marketing |  | $                                   | 15,254 |        | 19% |  | $ | 14,249 |  | 17% |  | 7% 
|                      |  |                                     |        |        |     |  |   |        |  |     |  |    

Selling and marketing expenses consist primarily of salary, stock-based compensation and commission expenses for our sales
force and related travel expenses and advertising and promotional expenses.

Stock based compensation expense was 8 and 6 percentage points, respectively of the 20%
and 7% increase in Selling and Marketing expense in the three and nine months ended June 30, 2005 compared with the same period of the prior year. The remaining increase reflected an increase in the sales and marketing headcount and salaries.
For the three and nine months ended June 30, 2006, $353,000 and $834,000 of Selling and Marketing expense was non-cash, stock-based compensation expense recorded pursuant to the October 1, 2005 prospective adoption of SFAS 123(R). This
amounted to 1% of revenue for the three and nine months ended June 30, 2006.

GENERAL AND ADMINISTRATIVE



|                           |  |                                     |       |        |    |  |   |       |  |    |  |     
|-------------------------- |  | ----------------------------------- | ----- | ------ | -- |  | - | ----- |  | -- |  | ----
|                           |  | Three Months Ended June 30,         |       | Change
|                           |  | 2006                                |       | 2005   |   
|                           |  | (in thousands & percent of revenue) |       |       
|                           |  |                                     |       |        |   
|General and administrative |  | $                                   | 2,268 |        | 7% |  | $ | 2,561 |  | 9% |  | -11%
|                           |  |                                     |       |        |    |  |   |       |  |    |  |     
|                           |  |                                    
|                           |  | Nine Months Ended June 30,          |       | Change
|                           |  | 2006                                |       | 2005   |   
|                           |  | (in thousands & percent of revenue) |       |       
|                           |  |                                     |       |        |   
|General and administrative |  | $                                   | 6,805 |        | 8% |  | $ | 6,785 |  | 8% |  | -   
|                           |  |                                     |       |        |    |  |   |       |  |    |  |     

General and administrative (G&A) expenses consist primarily of employee related expenses, legal and
accounting fees, and insurance costs.

G&A expenses decreased for the three months ended June 30, 2006 as compared to the same period in the prior year
primarily because of decreases to legal and professional fees as well as the benefit from insurance reimbursement of legal costs that were mostly offset by stock compensation expense.

G&A expenses were relatively consistent for the nine months ended June 30, 2006 as compared to the prior year due to the benefit from decreased legal and professional fees as well as insurance reimbursement of legal
costs being offset by increased stock compensation expense. For the three and nine months ended June 30, 2006, $428,000 and $1.5 million of G&A expense was non-cash stock-based compensation expense recorded pursuant to the October 1,
2005 prospective adoption of SFAS 123(R). This was 1% and 2% of revenue for the three and nine months ended June 30, 2006.



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RESTRUCTURING COSTS

Restructuring costs included in operating expenses were zero for the three and nine months ended June 30, 2006 compared to zero and $98,000 for the three and nine months ended June 30, 2005, respectively. During the three and nine
months ended June 30, 2005, we recorded a restructuring charge of $98,000, primarily employee termination and wind down costs associated with the closure of a sales office in the Netherlands and a development office in Germany.

GAIN ON EQUITY INVESTMENT

During quarter ended June 30, 2006, the Company
sold its equity investment in MegaPath Inc. in exchange for $734,000 cash and 1.7 Million shares of Series 2 preferred stock of Netifice Communications, Inc (Netifice). In accordance with the criteria of SFAS 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities  a replacement of FASB Statement 125, the Company accounted for the transaction as a transfer of an asset that qualified as a sale. Accordingly, the Company removed its
investment in MegaPath Inc. and recognized the cash received and its investment in Netifice at fair value, which resulted in a gain of $1.1 million in the Condensed Consolidated Statement of Operations.

Risk Factors

The risk factors discussed below should be considered carefully in
evaluating our business because these 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 (SEC), 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 nine months ended June 30, 2006, we incurred a net loss of $2.1 million and provided approximately $3.1 million of cash for operating activities. In each of the past three fiscal years ended September 30, we used
approximately $1.8 million, $5.2 million and $5.4 million, respectively, of cash for operating activities. Our cash and cash equivalents totaled $26.5 million at June 30, 2006. We may not be able to 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 cash, cash equivalents and borrowing capacity adequate to meet our



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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 the
private securities class action, the derivative actions and other government investigations and litigation related to and arising out of the restatements of our consolidated financial statements for prior periods in a timely and economic manner, our
business could be significantly harmed.

We currently are named as a defendant in a consolidated private securities class action. In addition, there are
purported derivative actions pending in state and federal court in California. We also have learned that the United States Attorney for the Northern District of California has opened an investigation following a referral by the SEC. We do not know
the scope or focus of the investigation by the United States Attorneys office. 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 private securities class action, the derivative actions and other government investigations and litigation matters related to the restatements also will likely continue to 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 operations. While we have provided notice of the government investigations and the other litigation matters to our directors and officers liability insurance carriers, the insurance carriers have
raised certain coverage issues and have not reimbursed us for all legal expenses incurred, and may not agree 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 legal expenses and 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 without continued expansion our revenues may decline, which could 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Improved business opportunities provided by deployment of broadband services by our Incumbent Local Exchange Carriers (ILECs) and other customers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | Government regulations.
| | - |  | -----------------------

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 using our NBBS software platform, 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.



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We expect our revenues to be 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. We have committed resources 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 difficulty in dislodging competitors whose products are currently being utilized, long-term product deployment cycles and intense price competition. ILECs currently obtain equipment from our competitors, which include 2Wire, Inc.,
Westell Technologies, Inc., Siemens AG (through its Siemens Subscriber Networks, Inc. subsidiary, formerly known as Efficient Networks), Thomson Corporation and ZyXEL Communications Co., which have proven to be strong competitors. All of these
competitors are larger than us and may have greater financial resources. There is no guarantee we will be successful in expanding our presence in the ILEC market. If we fail to further penetrate the ILEC market for our products and services, our
business may be materially and adversely affected.

We expect our revenues to be increasingly dependent on our ability to develop and sell our broadband equipment
into the residential broadband gateway market.

We are competing for sales of broadband equipment to ILECs serving the residential market. There are numerous
risks associated with the residential broadband gateway market including, but not limited to:



| |  |  | The ability to design and develop products that meet the needs of the residential market;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | The ability to market these products successfully to ILECs and to dislodge competitors that are currently supplying residential-class broadband gateways; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Intense price pressure.
| | - |  | -----------------------

If we are unable to increase our sales into the residential
broadband gateway market, our business will 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 our business.

We rely on a small number of customers for a large portion of our revenues. For the three
months ended June 30, 2006 and 2005, there were three customers that each individually represented at least 10% of our revenues and in the aggregate, accounted for 50% and 55%, respectively, of our total revenues. Our largest customer,
BellSouth Telecommunications, Inc., has entered into an agreement pursuant to which it will merge into AT&T (formerly SBC) following regulatory and shareholder approvals. While AT&T also is one of our largest customers, we believe that our
market share is larger at BellSouth than at AT&T, which we believe buys a significantly larger volume of broadband equipment from 2Wire, Inc., one of our competitors. AT&T also recently made an investment in 2Wire. There is no guarantee that
BellSouth will continue to buy our broadband equipment in the same volumes following the merger with AT&T. Certain of our other major customers also are reported from time to time in the press to be acquisition targets. The telecommunications
industry generally is experiencing consolidation as companies merge and acquire other companies. 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 for any reason, including industry consolidation.

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, 2006 and 2005, our international sales represented 46% and 39%, 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 certain of our European



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customers are denominated in Euros or Swiss francs. 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, which could result in decreased sales of our products and services. In addition, changes in the value of the Euro or Swiss franc
relative to the United States dollar could adversely affect our operating results to the extent we do not adequately hedge sales denominated in such foreign currencies.

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

Our international operations,
which principally are in Europe, 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;
| | - |  | -------------------------------------------------------



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



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



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



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



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

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 could cause 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.

In the market for broadband equipment, we primarily compete with 2Wire, Inc.,
Westell Technologies, Inc., Siemens AG (through its Siemens Subscriber Networks, Inc. subsidiary, formerly known as Efficient Networks), Thomson Corporation and ZyXEL Communications Co. In the market for our broadband software and services products,
we primarily compete with Motive, Inc., Supportsoft, Inc., 2Wire, Inc., Altiris, Inc., Computer Associates International, Inc., CrossTec Corporation, Expertcity, Inc., LANDesk Software, Inc., Microsoft Corporation and Symantec Corporation.

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 ours. 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.



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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 ended June 30, 2006, our revenues have ranged from $23.4 million to $30.5 million, and our net income (loss) has ranged from $0.6 million net income to ($6.1) million net loss. 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.

In certain quarters in the past, our operating results were below the expectations of some securities analysts. It 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;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | 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 residential-class ADSL products within our family of broadband equipment;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | Foreign currency fluctuations; and
| | - |  | ----------------------------------



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

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. We cannot guarantee that we will be able to
develop and introduce products for these competing technologies.

We purchase the semiconductor chips for our broadband equipment 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, which may include 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



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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 broadband 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. For example,
all broadband equipment imported into the European Union effective June 30, 2006 must comply with the Directive 2002/95/EC of the European Parliament on the restriction of the use of certain hazardous substances. The government of Switzerland
has adopted similar new regulations effective June 30, 2006. Compliance with these regulations has required us to redesign certain of our broadband equipment and to qualify different components. Any stoppage or delay in selling our products
related to a failure to redesign successfully our broadband equipment if and when required 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 broadband equipment.

Our Netopia Broadband Server (NBBS) software platform 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 is a relatively new product that has required and is expected to continue to require significant investment of development resources and to date has not generated
predictable recurring revenues, and we cannot provide any assurance that NBBS will be widely adopted by the customers to whom we are marketing it. In addition, we cannot provide any assurance that when and if deployed in mass scale, NBBS will
perform as expected or that it has no hidden bugs or defects.

We may not be able to develop, introduce, enhance or market successfully 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



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introduce rapidly new products that meet such requirements for performance, price, features and compatibility with other broadband equipment. Failure to continue to
develop and market competitive products would harm our competitive position and operating results.

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

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
residential-class DSL products are increasing, our overall gross margin rate will likely decrease. Further, we expect that the market for broadband equipment will remain highly competitive and as a result, we will 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.

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.

We anticipate that the
market for Timbuktu may continue to decline. With the exception of our agreement with BellSouth, we also have not generated significant revenue to date from the NBBS software platform in which we have made and expect to continue to make a
significant investment of development resources. We derive the majority of the recurring revenues from our broadband software and services products from fewer than five customers. If licensees of our eSite and eStore software do not successfully
promote web sites and stores to their customers, our recurring revenues may decrease. If these licensees were to choose a competitive platform, our recurring revenues would decline 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
NBBS, 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 NBBS, 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 NBBS, parental
controls, eSite and eStore hosting services. In such a circumstance, our hosting and subscription revenues may decline. In addition, if our NBBS, 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.

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.



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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 remote control technology incorporated in most of our software products. The term of this patent is through August 2010. We also have filed patent applications relating to the design of our
Wi-Fi 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, third parties have claimed and in the future may claim that our current
or potential future products 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.

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.

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.



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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:



| |  |  | Our ability to meet the listing standards and to obtain a relisting of our common stock on The Nasdaq Stock Market or a listing on The Nasdaq Capital Market;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | General conditions in the broadband communications industry.
| | - |  | ------------------------------------------------------------

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. Securities class action litigation has often been brought against a
company following periods of volatility in market price of its securities. We currently are and may in the future be the target of securities litigation. Securities litigation has resulted and is expected to continue to result in substantial costs
and diversion of 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.

Changes in the accounting treatment of stock options has and
will adversely affect our results of operations.

In December 2004, the FASB issued SFAS 123R, which is a revision of SFAS 123. SFAS 123R requires all
share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and does not permit pro forma disclosure as an alternative to financial statement recognition. The
adoption of the SFAS 123R fair value method effective as of October 1, 2005 has and will continue to have a significant adverse impact on our results of



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operations because the stock-based compensation expense is charged directly against our reported earnings. See Note 2 and 7 to the Consolidated Condensed Financial
Statements included in this Form 10-Q for further details.

PART I  FINANCIAL INFORMATION

ITEM 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest
Rate Risks

Our potential market interest rate risk for borrowings relates primarily to the rate charged by Silicon Valley Bank under our credit facility, from
which we had no borrowings at June 30, 2006. The credit facility bears interest at a rate equal to the prime rate (the rate announced by Silicon Valley Bank as its prime rate). To the extent interest rates increase and we make
borrowings under the credit facility, we would incur increased interest expense.

Foreign Currency Risks

Our exposure to foreign exchange risk relates primarily to sales and corresponding receivables made to international customers whose transactions are denominated in Euros or Swiss
francs. We are subject to risks related to fluctuations in foreign exchange rates. To minimize the effects of potential short-term fluctuations on our operating results due to our exposure to foreign currency exchange fluctuations, we enter into
foreign exchange forward contracts. These contracts guarantee a predetermined exchange rate at the time the contract is purchased. Our currency exchange contracts typically have maturities of three months or less. See Note 8 to the Consolidated
Condensed Financial Statements included in this Form 10-Q for further details.

ITEM 4.         CONTROLS AND PROCEDURES

Evaluation of disclosure controls and
procedures. Based on our managements evaluation (with the participation of our principal executive officer and principal accounting officer), as of the end of the period covered by this report, our principal executive officer and principal
accounting officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the Exchange Act)) are effective to ensure that information
required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

Changes in internal control over financial reporting. There was no change in our internal control over financial reporting during our third quarter of fiscal year 2006 that
has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II  OTHER INFORMATION

ITEM 1.         LEGAL PROCEEDINGS

On December 3, 2004, the United States District
Court for the Northern District of California issued an order consolidating previously filed purported class action cases under the name In re Netopia, Inc. Securities Litigation, and appointing lead plaintiffs and plaintiffs counsel.
On June 29, 2005, the lead plaintiffs filed their consolidated amended complaint. The consolidated amended complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the Exchange
Act). The consolidated amended complaint alleges that during the purported class period, November 6, 2003 through August 16, 2004, we made false and misleading statements or failed to disclose material facts, and that the market
price of our common stock was artificially inflated as a result of such alleged conduct. On June 21, 2006, the court granted the plaintiffs motion for class certification. We believe that we have strong defenses to the claims asserted in
the consolidated amended complaint. We intend to defend the case vigorously. We currently cannot estimate the extent of the potential damages in this dispute.

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 alleged misstatements described above in connection with the purported class action described
above. 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. On March 3, 2006, the plaintiffs 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. We currently cannot estimate the extent of the potential damages in this dispute.

In April 2005, we
learned that the United States Attorney for the Northern District of California has opened an investigation following a referral by the SEC. We do not know the scope or focus of the investigation.

In January 2005, we were notified by the Occupational Health and Safety Administration (OSHA) that we were 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 alleged that we terminated them in retaliation for
their participation in the internal accounting review conducted by the audit committee in 2004. On May 11, 2005, following its investigation, OSHA advised us that the complaint was determined to have no merit. On August 31, 2005, the two
former employees refiled these claims in the United States District Court for the Northern District of Texas in an action entitled Frankl v. Netopia et al. The complaint names the Company and certain current and former officers and directors
as defendants. The plaintiffs will be filing a motion to stay this action. We believe that our defenses to this action are strong and intend to defend it vigorously. We currently cannot estimate the extent of the potential damages in this dispute.
One of the plaintiffs in this action is a defendant in an action filed on March 29, 2006 and pending in the United States District Court for the Northern District of California entitled Securities and Exchange Commission v. Skoulis, Frankl
et al.

Defending against the government investigation, the private securities class action, the derivative actions and other litigation matters described above
will likely continue to 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 government investigation and the litigation matters described above to our directors and
officers liability insurance carriers, the insurance carriers have raised certain coverage issues and to date have not reimbursed us for all legal expenses incurred, and may not agree that they



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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 legal expenses and 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.

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) During the three months ended June 30, 2006, we filed one Current Report on Form 8-K on April 26, 2006,
reporting Items 2.02 and 9.01, disclosing our financial results for the second fiscal quarter ended March 31, 2006 as well as certain other information.

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: August 9, 2006 |  | NETOPIA, INC. (Registrant)
|                     |  |                           
|                     |  | By:                        |  | /s/ Alan B. Lefkof                                                                     
|                     |  |                            |  | Alan B. Lefkof                                                                         
|                     |  |                            |  | President and Chief Executive Officer                                                  
|                     |  |                           
|                     |  | By:                        |  | /s/ Charles Constanti                                                                  
|                     |  |                            |  | Charles Constanti                                                                      
|                     |  |                            |  | Vice President and Chief Financial Officer (Principal Financial and
Accounting Officer)



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