---




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 December 31, 2001





OR





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




For the transition period from  to





Commission file number 0-28450





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Netopia, Inc.


(Exact name of registrant as specified in its charter)





Delaware (State or other jurisdiction of incorporation or
organization)

94-3033136 (I.R.S. Employer Identification
Number)





2470 Mariner Square Loop


Alameda, California 94501


(Address of principal executive offices, including Zip Code)





---




(510) 814-5100


(Registrants telephone number, including area code)





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Indicate by ücheck 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  þ    No  ̈





As of December 31, 2001 there were 18,120,412 shares of the Registrants common stock outstanding.





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NETOPIA, INC.





FORM 10-Q





TABLE OF CONTENTS





PagePART I.

FINANCIAL INFORMATIONITEM 1.

UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

2CONDENSED CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, 2001 (UNAUDITED) AND SEPTEMBER 30, 2001 (AUDITED)

2UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000

3UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000

4NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

5ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

12ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

30PART II.

OTHER INFORMATIONITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

31SIGNATURE

32




1




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PART I.    FINANCIAL INFORMATION





ITEM 1.    CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





NETOPIA, INC. AND SUBSIDIARIES





CONDENSED CONSOLIDATED BALANCE SHEETS





December 31, 2001


September 30, 2001(in thousands, except share and per share amounts)ASSETSCurrent assets:Cash and cash equivalents

$
32,392


$
35,703Short-term investments


33



13,293Trade accounts receivable less allowance for doubtful accounts and returns of $1,066 and $641, respectively


8,809



9,550Inventories, net


9,219



7,156Prepaid expenses and other current assets


1,754



1,634Total current assets


52,207



67,336Furniture, fixtures and equipment, net


6,358



5,770Intangible assets, net


18,319



2,758Long-term investments


4,000



4,000Deposits and other assets


2,258



2,848$
83,142


$
82,712LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
8,886


$
4,713Accrued compensation


2,889



2,148Accrued liabilities


2,975



1,116Deferred revenue


2,252



2,589Other current liabilities


214



177Total current liabilities


17,216



10,743Long-term liabilities


127



256Total liabilities


17,343



10,999Commitments and contingenciesStockholders equity:Common stock: $0.001 par value, 50,000,000 shares authorized; 18,120,412 and 18,076,812 shares issued and outstanding at December 31
and September 30, 2001, respectively


18



17Additional paid-in capital


145,041



144,886Accumulated deficit


(79,260
)


(73,190
)Total stockholders equity


65,799



71,713$
83,142


$
82,712





See accompanying notes to condensed consolidated financial statements.




2




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NETOPIA, INC. AND SUBSIDIARIES





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS





Three months ended December 31,2001


2000(in thousands, except per share amounts)Revenues:Internet equipment

$
11,811


$
14,845Web platform licenses and services


4,074



5,548Total revenues


15,885



20,393Cost of revenues:Internet equipment


7,383



9,795Web platform licenses and services


164



201Total cost of revenues


7,547



9,996Gross profit


8,338



10,397Operating expenses:Research and development


4,148



3,669Selling and marketing


6,128



7,185General and administrative


973



3,143Restructuring costs


482



Integration costs


309



Acquired in-process research and development


2,150



Amortization of goodwill and other intangible assets


374



2,996Total operating expenses


14,564



16,993Operating loss


(6,226
)


(6,596
)Other income (loss):Loss on impaired securities






(981
)Other income, net


156



973Total other income


156



(8
)Loss from continuing operations before cumulative effect from adoption of Staff Accounting Bulletin 101


(6,070
)


(6,604
)Cumulative effect from adoption of Staff Accounting Bulletin 101






(1,555
)Net loss

$
(6,070
)

$
(8,159
)Per share data, net loss:Net loss per share

$
(0.34
)

$
(0.46
)Shares used in the per share calculations


18,092



17,607





See accompanying notes to condensed consolidated financial statements.




3




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NETOPIA, INC. AND SUBSIDIARIES





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS





Three months ended December 31,2001


2000(in thousands)Cash flows from operating activities:Net loss

$
(6,070
)

$
(8,159
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


2,593



3,732Charge for acquired in-process research and development


2,150



Unrealized loss on impaired securities






981Changes in allowance for doubtful accounts and returns on accounts receivable


427



1,668Changes in operating assets and liabilities:Trade accounts receivable


313



(435
)Inventories


(2,063
)


(1,195
)Prepaid expenses and other current assets


(120
)


(1,886
)Deposits and other assets


3



(10
)Accounts payable and accrued liabilities


6,774



(668
)Deferred revenue


(443
)


1,344Other liabilities


14



1,691Net cash provided by (used in) operating activities


3,578



(2,937
)Cash flows from investing activities:Purchase of furniture, fixtures and equipment


(2,576
)


(1,200
)Capitalization of software development costs






(211
)Acquisition of intangibles


(17,729
)


Purchase of long-term investment






(2,000
)Purchase of short-term investments


147



(12,764
)Proceeds from the sale and maturity of short-term investments


13,113



18,628Net cash provided by (used in) investing activities


(7,045
)


2,453Cash flows from financing activities:Proceeds from the issuance of common stock, net


156



75Net cash provided by financing activities


156



75Net decrease in cash and cash equivalents


(3,311
)


(409
)Cash and cash equivalents, beginning of period


35,703



37,839Cash and cash equivalents, end of period

$
32,392


$
37,430








See accompanying notes to condensed consolidated
financial statements




4




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NETOPIA, INC. AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





(1)    Basis of Presentation





The unaudited condensed consolidated financial statements included in this Form 10-Q reflect all adjustments, consisting only of normal recurring adjustments which in the Companys opinion are necessary to fairly
present the Companys consolidated financial position, results of operations and cash flows for the periods presented. These condensed consolidated financial statements should be read in conjunction with the Companys consolidated
financial statements included in the Companys Annual Report on Form 10-K and other filings with the United States Securities and Exchange Commission (SEC). The consolidated results of operations for the period ended December 31, 2001 are not
necessarily indicative of the results to be expected for any subsequent quarter or for the entire fiscal year ending September 30, 2002.





(2)    Recent Accounting Pronouncements





In June 1998, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 133, Accounting for Derivative and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments (including derivative
instruments embedded in other contracts) and for hedging activities. SFAS No. 133, as amended by SFAS No. 137, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company adopted SFAS No. 133 in its fiscal first
quarter of 2001 which did not have a material effect on its balance sheet or statement of operations.





In December 1999, the SEC
issued Staff Accounting Bulletin (SAB) 101, Revenue Recognition in Financial Statements. SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. The Company adopted
SAB 101 in its fiscal first quarter of 2001 resulting in a change in the accounting for certain revenue contracts that include nonrefundable upfront payments from customers. As a result of the adoption of SAB 101, the Company recorded a $1.6 million
charge to its statement of operations and a $1.6 million increase in deferred revenue to its consolidated balance sheet.





In
July 2001, the FASB issued SFAS No. 141, Business Combinations. SFAS No. 141 requires that all business combinations be accounted for under the purchase method. The use of the pooling-of-interests method is no longer permitted. SFAS No. 141
requires that the purchase method be used for business combinations initiated after June 30, 2001. The Company adopted the provisions of SFAS No. 141 on July 1, 2001. To date, the Company has accounted for all of its business combinations as
purchases and the adoption of SFAS No. 141 is not expected to have a significant impact on the Companys financial position or results of operations.





In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that goodwill resulting from a business combination no longer be amortized to earnings, but instead be
reviewed for impairment on at least an annual basis and be expensed against earnings when the implied fair value of a reporting unit is less than its carrying amount. The Company elected to early adopt SFAS No. 142 as of October 1, 2001. For
goodwill resulting from business combinations prior to July 1, 2001, amortization of such goodwill continued through September 30, 2001, but ceased commencing on October 1, 2001. For business combinations occurring on or after July 1, 2001, the
associated goodwill will not be amortized. The Company is currently in the process of performing its tests for goodwill impairment and expects to complete such analysis within 6 months of adoption as provided in SFAS No. 142.





In August 2001 the FASB issued SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 serves to clarify and
further define the provisions of SFAS No. 121 Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. SFAS No. 144 does not apply to goodwill and other intangible assets that are not amortized. SFAS No. 144 is
effective for fiscal years beginning after December 15, 2001. The Company expects to adopt SFAS No. 144 effective October 1, 2002. The effect of adopting this statement is not expected to have a material effect on the Companys consolidated
financial position or results of operations.




5




---








(3)    Inventories





Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method. Net inventories consisted of the following:





December 31, 2001

September 30, 2001(in thousands)Raw materials

$
4,413

$
3,530Work in process


115


927Finished goods


4,691


2,699$
9,219

$
7,156





(4)    Net Loss Per Share





Basic net loss per share (EPS) is based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is based on the weighted average number
of shares of common stock outstanding during the period and dilutive common equivalent shares from options and warrants outstanding during the period. Potentially dilutive common equivalent shares have been excluded from the computation of diluted
EPS for the three months ended December 31, 2001 and 2000 since their effect on EPS is antidilutive due to the losses incurred in each period. The following table sets forth the computation of basic and diluted net loss per
share:





Three months ended December 31,2001


2000(in thousands, except per share amounts)Net loss

$
(6,070
)

$
(8,159
)Weighted average number of common stock outstanding


18,092



17,607Basic and diluted net loss per common share

$
(0.34
)

$
(0.46
)





Potentially dilutive common equivalent shares which were excluded from the
computation of diluted EPS consisted of options to purchase common stock totaling 5,249,656 shares for the three months ended December 31, 2001; 5,187,248 shares for the three months ended December 31, 2000; and a warrant to purchase common stock
totaling 5,000 shares for the three months ended December 31, 2001 and 2000.





(5)    Segment, Geographic and Significant Customer
Information





Segment Information





The methodology for determining the segment information reported is based on the organization of operating segments and the related information that the Chief Operating Decision Maker
(CODM) uses for operational decisions and assessing financial performance. Netopias Chief Executive Officer (CEO) is considered the Companys CODM. For purposes of making operating decisions and assessing financial performance, the
Companys CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information for revenues and gross margins by product group as well as revenues by geographic region and by customer. Operating expenses
and assets are not disaggregated by product group for purposes of making operating decisions and assessing financial performance.




6




---








The Company generates revenue from two groups of products and services.
Disaggregated financial information regarding the operating segments is as follows:





Three months ended December 31,2001


2000Internet Equipment


Web Platform


Total


Internet Equipment


Web Platform


Total(in thousands)Revenue

$
11,811


$
4,074


$
15,885


$
14,845


$
5,548


$
20,393Cost of revenues


7,383



164



7,547



9,795



201



9,996Gross profit


4,428



3,910



8,338



5,050



5,347



10,397Gross margin


37
%


96
%


52
%


34
%


96
%


51
%Unallocated operating expenses










14,564











16,993Operating loss









$
(6,226
)









$
(6,596
)





Geographic Information





The Company sells its products and provides services worldwide through a direct sales force, independent distributors, and value-added resellers. It
currently operates in four regions: United States, Europe, Canada, and Asia Pacific and other. Revenues outside of the United States are primarily export sales denominated in United States dollars. The Company does not have material operating assets
outside of the United States. Disaggregated financial information regarding the Companys revenues by geographic region is as follows:





Three months ended December 31,2001


2000(in thousands)Europe

$
1,839

12
%

$
2,923

14
%Canada


230

1
%


401

2
%Asia Pacific and other


311

2
%


252

1
%Subtotal international revenue


2,380

15
%


3,576

17
%United States


13,505

85
%


16,817

83
%Total revenues

$
15,885

100
%

$
20,393

100
%





Customer Information





Historically, the Company has sold its products to competitive local exchange carriers (CLECs), distributors, incumbent local exchange carriers (ILECs), Internet service providers
(ISPs) and directly to end-users. Disaggregated financial information regarding the Companys customers who accounted for 10% or more of the Companys revenue is as follows:





Three months ended December 31,2001


2000(in thousands)Ingram Micro

$
1,928

12
%

$
1,076

5
%Rhythms NetConnections(a)








3,520

17
%Network Telephone


30





2,486

12
%


---

|(a) |  | Rhythms received Bankruptcy Court approval and completed the sale of a substantial portion of its assets to Worldcom in December 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------



7




---








No other customers during the three months ended December 31, 2001 and 2000
accounted for 10% or more of the Companys total revenues. The following table sets forth the accounts receivable balance for the customers identified above along with such data expressed as a percentage of total accounts receivable:





Three months ended December 31,2001


2000(in thousands)Ingram Micro

$
1,256

14
%

$
923

10
%Rhythms Netconnections








1,758

18
%Network Telephone


7





2,273

24
%





(6)    Acquisitions





On October 11, 2001, the Company and Cayman Systems, Inc. (Cayman), a Massachusetts corporation, consummated a merger (the Merger) whereby Amazon Merger Corporation, a Delaware
corporation and a wholly-owned subsidiary of Netopia (Merger Sub), was merged with and into Cayman pursuant to an Agreement and Plan of Merger and Reorganization (the Merger Agreement) dated as of September 19, 2001, as amended. Cayman, a developer
and supplier of business class broadband gateways, has survived the Merger as a wholly-owned subsidiary of Netopia.





The Company
accounted for the transaction under the purchase method. The aggregate purchase price of the transaction was $14.8 million, based on the consideration paid at closing. The aggregate purchase price included:





| |  |  | $6.0 million in cash in exchange for all of Caymans outstanding equity, including in-the-money stock options;
| | - |  | --------------------------------------------------------------------------------------------------------------




| |  |  | $4.2 million in cash in exchange for all of Caymans outstanding convertible debt;
| | - |  | ----------------------------------------------------------------------------------




| |  |  | $2.4 million in cash in respect of an outstanding credit line of Cayman;
| | - |  | ------------------------------------------------------------------------




| |  |  | $0.9 million in cash in fees to Caymans investment bankers, attorneys and accountants;
| | - |  | ---------------------------------------------------------------------------------------




| |  |  | $0.6 million in cash for the Companys transaction costs including legal, accounting and other professional services; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------




| |  |  | $0.7 million cash in severance benefits to Cayman employees that were not retained.
| | - |  | -----------------------------------------------------------------------------------




The Company also assumed certain other liabilities of Cayman.





Approximately $1.7 million is being held in escrow to satisfy Caymans indemnification obligations under the Merger Agreement. Upon the satisfaction of Caymans indemnification obligations, certain amounts are be released from
escrow on the one year anniversary date of the close of the transaction and any remaining amounts are to be released from escrow on the two year anniversary date of the close of the transaction




8




---








The allocation of the purchase price is based upon the Companys estimates
of the fair value of the tangible and intangible assets acquired and is as follows:





Amount


Annual amortization

Useful life(in thousands)Current assets

$
5,334



n/a

n/aLong-term assets


895



n/a

n/aCurrent liabilities


(9,543
)


n/a

n/aIdentified intangible assets:Developed product technology


1,120


$
224

5 yearsCore technology leveraged


5,570



928

6 yearsSales channel relationships


1,380



345

4 yearsGoodwill


7,919



n/a

n/aAcquired in-process research and development


2,150



n/a

n/aTotal purchase price

$
14,825


$
1,497





The allocation of the total purchase price of Cayman to its individual assets
offset by liabilities was supported by an allocation performed by an independent third party-valuation specialist. In addition to the current assets and liabilities that were acquired, certain intangible assets were identified and a portion of the
purchase price was allocated to acquired in-process research and development projects. These identified intangible assets are as follows:





| |  |  | Developed product technology, which represents the value of Caymans proprietary know-how that is technologically feasible as of the acquisition date;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Core technology leveraged, which represents the value of Caymans research and development projects in process that are leveraged off of Caymans previously developed
products and technology;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Sales channel relationships, which represents the value of Caymans established relationships with its ILEC and cable company customers to whom Netopia expects to continue
to sell products; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Goodwill, which represents the excess of the Cayman purchase price over the fair value of the underlying net identifiable assets. Included in goodwill is $2.5 million,
representing the fair value of the assembled workforce. Pursuant to SFAS No. 141, Business Combinations, the value of such assembled workforce should not be reported separately from goodwill. Also included in goodwill is a $1.2 million
liability to fully reserve the excess space at the Cayman facilities resulting from the termination of employees whose positions were determined to be redundant subsequent to the closing of the Cayman acquisition and $1.2 million related to
recording the fair value of Cayman inventory purchase commitments. The Company believes that the amount allocated to goodwill appropriately reflects the market value of the amount of purchase price over the fair value of the underlying net
identifiable assets based upon the value in the expansion of the Companys product offerings and expected synergies resulting from the acquisition.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




The estimated useful lives of developed product technology, core technology leveraged and sales channel relationships are 5, 6 and 4 years, respectively. Netopia will amortize the value
of these identified intangible assets on a straight-line basis over their estimated useful lives.





Cayman was developing new
products that qualified as in-process research and development. In-process research and development is defined as acquired research and developments assets that are not currently technologically feasible. In accordance with SFAS No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, the costs of internally developed products are expensed until the product has established technological feasibility. Technological feasibility is
determined when a product reaches the working model stage, which is generally when the product has reached the beta version release. Beta products are operative versions of the products that perform all of the major functions planned for
the product, and are ready for initial customer testing. Netopia believes that each of the in-process research and development projects acquired are subject to significant further development before they will be available for release to our
customers. Developing these products is time consuming, costly and complex and there is a risk that these developments will be late, fail to meet customer or market requirements and may not be competitive with other products using similar or
alternative technologies that offer comparable functionality.




9




---








The value that was assigned to acquired in-process research and development as
part of the Companys independent third-party valuation was determined by estimating the costs to develop the in-process research and development projects into commercially viable products, estimating the resulting net cash flows from the
projects when completed and discounting the net cash flows to their present value. The revenue estimates used to value the in-process research and development projects were based upon estimates of relevant market sizes and growth factors, expected
trends in technology and the nature and expected timing of new product introductions by Cayman and its competitors.





The rate
utilized to discount the net cash flows to their present value was 28% which Netopia believes adequately reflects the nature of the investment and the risk of the underlying cash flows. This discount rate is a weighted average cost of capital based
upon a peer group of companies.





(7)    Intangible Assets





Intangible assets consist of amounts allocated to goodwill and other intangible assets in connection with the Companys acquisitions. Detail of the Companys intangible assets
as of December 31, 2001 is as follows:





Acquisition date

Amount allocated to goodwill and other intangible assets

Accumulated amortization

Impairment charges

Net value at December 31, 2001Cayman

October 2001

$
15,989

$
374

$


$
15,615WebOrder

March 2000


17,119


7,009


9,592


518Starnet Technologies

October 1999


21,165


13,255


6,089


1,821netOctopus

December 1998


961


596





365$
55,234

$
21,234

$
15,681

$
18,319





(8)    Restructuring Costs





During the three months ended December 31, 2001, the Company recorded a restructuring charge of $0.5 million in connection with a reduction in the
Companys workforce of approximately 24 people whose positions were determined to be redundant subsequent to the closing of the Cayman acquisition. The charge consisted primarily of employee severance benefits. Details of the restructuring
charge is as follows (in thousands):





Total charge

$
482Less:Amounts paid


256Non-cash charges


58Balance at December 31, 2001

$
168





(9)    Integration Costs





During the three months ended December 31, 2001, the Company recorded a charge of $0.3 million for integration costs incurred in connection with integrating Caymans customers,
systems and operations. Details of the charge for integration costs is as follows:





Customer integration communications

Systems integration

Total(in thousands)Total charge

$
269

$
40

$
309Less:Amounts paid


269





269Balance at December 31, 2001

$


$
40

$
40




10




---








(10)    Long-Term Investments





During the three months ended December 31, 2000, the Company purchased $2.0 million of Series D Preferred stock in MegaPath. MegaPath offers high-speed
DSL access and eCommerce and Web hosting services to small and medium size businesses. During fiscal year 2000, MegaPath had purchased the Companys broadband Internet equipment and licensed certain of our Web platform products. Although there
is no public market for MegaPaths stock, the Company believes the market value of these shares is not less than $2.0 million.





During the three months ended September 30, 2000, the Company purchased $2.0 million of Series C Preferred Stock in Everdream. Everdream provides outsourced information technology (IT) expertise, products and services that enable small and
medium size businesses to focus on their core competencies. In April 2000, the Company entered into an agreement with Everdream to host a co-branded version of the Companys eStore platform for Everdreams customers. Although there is no
public market for Everdreams stock, the Company believes that the market value of these shares is not less than $2.0 million.




11




---




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, expect, anticipate, believe, estimate 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 l. The risk factors listed 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 trading price of our common stock could decline.





Overview





We develop, market and support
broadband Internet equipment and Web platform software solutions. Our platforms are designed to enable our telecommunications carrier, distributor and Internet service provider (ISP) customers create and offer expanded broadband service offerings
focused on the needs of distributed enterprises, small and medium size businesses, small office/home office professionals, and multi-PC households. These service offerings often include digital subscriber line (DSL) service bundled with back-up,
bonding, virtual private networking (VPN), voice over DSL, and eSite and eStore hosting.





Our broadband Internet
equipment products consist principally of DSL routers and integrated access devices (IADs) which enable the transmission of data and/or voice over DSL networks as well as Cable Ethernet, T1/Frame Relay, integrated services digital network (ISDN) and
dual analog routers. Our Web platform software products consist principally of the eSite, eStore and eCare products, sold through our telecommunications carrier partners that provide Web sites and eCommerce enabled Web sites as well as electronic
customer relation management (eCRM) and system management software, and Timbuktu Pro products, primarily sold to enterprise and distribution customers that provide help desk and systems management applications.





We primarily sell our products to:





| |  |  | Telecommunication carriers, such as: incumbent local exchange carriers (ILECs), such as SBC, BellSouth and Verizon; competitive local exchange carriers (CLECs), such as Covad
and McLeod; Internet service providers (ISPs), such as Business Telecommunications and Onsite Access; Internet Exchange Carriers (IXCs) such as AT&T, Sprint and Worldcom;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Distributors, such as Ingram Micro, Softway and Tech Data;
| | - |  | ----------------------------------------------------------




| |  |  | Cable companies such as Comcast and AT&T Broadband; and
| | - |  | -------------------------------------------------------




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




We have
historically depended upon the ability of CLECs and ISPs to offer broadband services successfully and become sustainable businesses. Several of our CLEC and ISP customers have incurred operating losses and negative cash flows as they attempted to
establish their networks and operations, and filed for protection under the Bankruptcy Act or ceased operations. Most notably, Covad, which currently is our largest CLEC customer, filed a voluntary petition under the Bankruptcy Act in August 2001 as
part of a capital restructuring plan. On November 13, 2001, Covad announced that it had secured an agreement with SBC to provide Covad with $150 million in funding. Covad announced on December 13, 2001 that it received approval of its reorganization
plan from the Bankruptcy Court and emerged from bankruptcy on December 20, 2001 upon closing the SBC funding. Additionally, Covad has announced that this funding is expected to provide the cash that it believes will allow it to become cash flow
positive by the latter half of 2003.




12




---




Results of Operations for the Three Months Ended December 31, 2001 and 2000





The following table sets forth for the periods indicated, certain statement of operations data, such data expressed as a percentage of revenues as well
as the change from the same period in the prior year.





Three months ended December 31,

Percentage increase/(decrease) from same period in prior year2001

2000(in thousands)Revenues:Internet equipment

$
11,811


74%

$
14,845


73%

(20%)Web platform licenses and services


4,074


26%


5,548


27%

(27%)Total revenues


15,885


100%


20,393


100%

(22%)Cost of revenues:Internet equipment


7,383


47%


9,795


48%

(25%)Web platform licenses and services


164


1%


201


1%

(18%)Total cost of revenues


7,547


48%


9,996


49%

(24%)Gross profit


8,338


52%


10,397


51%

(20%)Operating expenses:Research and development


4,148


26%


3,669


18%

13%Selling and marketing


6,128


39%


7,185


35%

(15%)General and administrative


973


6%


3,143


15%

(69%)Restructuring costs


482


3%







Integration costs


309


2%







Acquired in-process research and development


2,150


14%







Amortization of goodwill and other intangible assets


374


2%


2,996


15%

(88%)Total operating expenses


14,564


92%


16,993


83%

(14%)Operating loss


(6,226
)

(40%)


(6,596
)

(32%)

(6%)Other income (loss):Loss on impaired securities








(981
)

(5%)

100%Other income, net


156


1%


973


5%

(84%)Total other income


156


1%


(8
)

(0%)

2,050%Loss from continuing operations before cumulative effect from adoption of Staff Accounting Bulletin 101


(6,070
)

(39%)


(6,604
)

(32%)

(8%)Cumulative effect from adoption of Staff Accounting Bulletin 101








(1,555
)

(8%)

100%Net loss

$
(6,070
)

(39%)

$
(8,159
)

(40%)

(26%)





Revenue





Total revenue for the three months ended December 31, 2001 decreased from the three months ended December 31, 2000 due to declining average selling prices of our broadband Internet
equipment and reduced license sales of our Web platform products.





| |  |  | Broadband Internet equipment revenue decreased due to declining average selling prices of our broadband Internet equipment, particularly our DSL routers, worldwide as a result
of price competition, pricing strategies as we enter new markets and channels and increased percentage of sales of our asynchronous digital subscriber line (ADSL) routers primarily to SBC and BellSouth, customers we acquired in connection with the
acquisition of Cayman Systems, Inc. (Cayman) in October 2001. Our ADSL routers have a lower average selling price than our other DSL routers.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



13




---




| |  |  | Web platform revenue decreased due to reduced license sales of our eSite and eStore products and reduced volume license sales of Timbuktu Pro, our system management software,
as a result of companies reducing their information technology (IT) spending due to the current macro-economic environment and as a result of the financial difficulties encountered by many of the .com customers to whom we licensed our
eSite and eStore products. This decrease was partially offset by increased recurring revenue from the hosting of our eSite and eStore products and increased revenue from the shrink-wrap version of Timbuktu Pro.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Historically, we have sold our products primarily to CLECs, distributors, ILECs, ISPs and directly to end-users. The
following table sets forth for the periods indicated, our customers who have represented greater than 10% of our revenues in such period, along with such data expressed as a percentage of total revenues as well as the change from the same period in
the prior year:





Three months ended December 31,


Percentage increase/(decrease) from same period in prior year2001


2000(in thousands)Ingram Micro

$
1,928

12
%

$
1,076

5
%

79
%Rhythms Netconnections(a)








3,520

17
%

(100
%)Network Telephone


30





2,486

12
%

(99
%)


---

|(a) |  | Rhythms received Bankruptcy Court approval and completed the sale of a substantial portion of its assets to Worldcom in December 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------




No other customers during the three months ended December 31, 2001 and 2000 accounted for 10% or more of the Companys total revenues.
For the three months ended December 31, 2001, there were four customers who each individually represented at least 5% of our revenues and in the aggregate, accounted for 39% of our total revenues. For the three months ended December 31, 2000, there
were five customers who each individually represented at least 5% of our revenues and in the aggregate, accounted for 52% of our total revenues.





The following table sets forth for the periods indicated, revenues by region for such period along with such data expressed as a percentage of total revenues as well as the change from the same period in the prior
year:





Three months ended December 31,


Percentage increase/(decrease) from same period in prior year2001


2000(in thousands)Europe

$
1,839

12
%

$
2,923

14
%

(37
%)Canada


230

1
%


401

2
%

(43
%)Asia Pacific and other


311

2
%


252

1
%

23
%Subtotal international revenue


2,380

15
%


3,576

17
%

(33
%)United States


13,505

85
%


16,817

83
%

(20
%)Total revenues

$
15,885

100
%

$
20,393

100
%

(22
%)





Total revenue for the three months ended December 31, 2001 decreased from the
three months ended December 31, 2000 due to declining average selling prices of our broadband Internet equipment as a result of price competition and pricing strategies as we enter new markets and channels and reduced volume license sales of our
Timbuktu pro products as a result of companies reducing their IT spending due to the current macro-economic environment.





Cost of Revenues





Cost of revenues consist primarily of material costs related to our contract manufacturing
organization and manufacturing variances. Total cost of revenues decreased for the three months ended December 31, 2001 from the




14




---

three months ended December 31, 2000 primarily as a result of declining material costs for our broadband Internet equipment. Our total gross margin increased to 52% for the three months ended
December 31, 2001 from 51% for the three months ended December 31, 2000. Broadband Internet equipment gross margin increased to 37% for the three months ended December 31, 2001 from 34% for the three months ended December 31, 2000. Broadband
Internet equipment gross margins increased as a result of the average material cost of our products declining more quickly than the average selling price. Web platform gross margin remained unchanged at 96% for the three months ended December 31,
2001 and 2000.





Our Internet equipment products have a lower average gross margin than our Web platform products. Accordingly,
to the extent we sell more Internet equipment than Web platform products, our gross margins would be lower. In the past, our gross margin has varied significantly and will likely vary significantly in the future. Our gross margins depend primarily
on:





| |  |  | The mix of Internet equipment and Web platform products sold;
| | - |  | -------------------------------------------------------------




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




| |  |  | Standard cost changes;
| | - |  | ----------------------




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




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




Research and Development





Research and development
expenses consist primarily of employee related expenses, depreciation and amortization, development related expenses such as product prototyping, design and testing, and overhead allocations. Research and development expenses increased for the three
months ended December 31, 2001 from the three months ended December 31, 2000 primarily due to:





| |  |  | Increased research and development headcount and employee related expenses as a result of our acquisition of Cayman and its research and development staff; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Increased depreciation expense as a result of increased capital purchases related to development of our broadband Internet equipment and the acquisition of Caymans
development assets.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




These increases were partially offset by reduced use of third party contractors and
reduced product prototyping and design expenses.





We expect to continue to devote substantial resources to product and
technological development. We expect research and development costs may increase in absolute dollars for the remainder of fiscal year 2002 and into fiscal year 2003 as we continue to expand the breadth and depth of our product offerings. We believe
our process for developing software is essentially completed concurrently with the establishment of technological feasibility, and we have not capitalized any internal software development costs to date. However, during the three months ended
December 31, 2000, we capitalized $0.2 million of software development costs incurred subsequent to the delivery of a working model, under a development agreement with third parties.





Selling and Marketing





Selling and marketing expenses
consist primarily of salary and commission expense for our sales force, travel and entertainment, advertising and promotional expenses, product marketing, customer service and support costs. Selling and marketing expenses decreased for the three
months ended December 31, 2001 from the three months ended December 31, 2000 primarily due to:





| |  |  | Decreased sales and marketing headcount and employee related expenses as well as decreased travel and entertainment expenses as a result of our restructuring in October 2001;
and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Decreased marketing programs and activities.
| | - |  | --------------------------------------------



15




---




We expect selling and marketing expenses may increase in absolute dollars for the remainder of
fiscal year 2002 as we try to expand the channels through which we sell our products and increase the number of customers to whom we sell our products.





General and Administrative





General and administrative expenses consist primarily of
employee related expenses, provisions for doubtful accounts and legal, accounting and insurance costs. General and administrative expenses decreased for the three months ended December 31, 2001 from the three months ended December 31, 2000 primarily
due to reduced incremental provisions for doubtful accounts for outstanding accounts receivable owed by our CLEC customers that filed voluntary petitions under the Bankruptcy Act and many of which ceased operations. Included in general and
administrative expense during the three months ended December 31, 2000 is $2.0 million of provisions for doubtful accounts, of which $1.7 million was related to the outstanding accounts receivable of Northpoint Communications.





We expect general and administrative expenses will remain relatively unchanged for the remainder of fiscal year 2002.





Restructuring Costs





During the three months ended December 31, 2001, we recorded a charge for restructuring costs of $0.5 million in connection with a reduction in the Companys workforce of approximately 24 people whose positions were determined to be
redundant subsequent to the closing of the Cayman acquisition. The charge consisted primarily of employee severance benefits. (See Note 8 of Notes To Condensed Consolidated Financial Statements.)





Integration Costs





During the three months ended
December 31, 2001, we recorded a charge of $0.3 million for integration costs incurred in connection with integrating Caymans customers, systems and operations. (See Note 9 of Notes To Condensed Consolidated Financial Statements.)





Acquired In-Process Research and Development





Acquired in process research and development represents research and development assets acquired in connection with our acquisition of Cayman that were not technologically feasible at
the time of acquisition and had no alternative future use, and as such were expensed at the time of the transaction. (See Note 6 of Notes To Condensed Consolidated Financial Statements.)





Amortization of Goodwill and Other Intangible Assets





For
the three months ended December 31, 2001, we amortized the amounts allocated to intangible assets with identifiable lives related to our acquisition of Cayman. (See Note 6 of Notes To Condensed Consolidated Financial Statements.)





For the three months December 30, 2000, amortization of goodwill and other intangible assets represents the amortization of such amounts
allocated to goodwill and other intangible assets related to our acquisitions of WebOrder, StarNet, Serus and netOctopus.





We
adopted the provisions of SFAS No. 142 on October 1, 2001, and as such, will no longer amortize the amounts allocated to goodwill and other intangible assets with undeterminable lives related to our acquisitions of WebOrder, StarNet and netOctopus,
nor will we amortize the amounts allocated to goodwill and other intangible assets with undeterminable lives related to our acquisition of Cayman. (See Note 2 of Notes To Condensed Consolidated Financial Statements.)




16




---




Other Income





Other income, net primarily consists of interest income we earn on our cash, cash equivalents and short-term investments in addition to both realized and unrealized gains and losses on
foreign currency transactions as well as losses on impaired securities that we deem other than temporary. We recorded a loss on impaired securities in the three months ended December 31, 2000 to reflect the other than temporary decline in the value
of our investment in Northpoint. Other income, net decreased for the three months ended December 31, 2001 from the three months ended December 31, 2000 due to our reduced cash, cash equivalents and short-term investments combined with a reduction in
interest rates from the prior fiscal year.





Provision for Income Taxes





We did not record an income tax benefit for the three months ended December 31, 2001 and 2000 primarily due to continued substantial uncertainty
regarding our ability to realize our deferred tax assets. Based upon available objective evidence, there has been sufficient uncertainty regarding the realizability of our deferred tax assets to warrant a valuation allowance in our financial
statements. The factors considered included prior losses, inconsistent profits, and lack of carryback potential to realize our deferred tax assets. Based on our outlook for fiscal year 2002 and beyond, we believe the uncertainty regarding the
realizability of our deferred tax assets may diminish to the point where it is more likely than not that our deferred tax assets will be realized. At such point, we would also reverse all or a portion of our valuation allowance which will result in
an income tax benefit.





Cumulative Effect from Adoption of Staff Accounting Bulleting 101





In December 1999, the SEC issued SAB 101, Revenue Recognition in Financial Statements. SAB 101 provides guidance on applying generally accepted
accounting principles to revenue recognition issues in financial statements. We adopted SAB 101 in the three months ended December 31, 2000 and recorded a $1.6 million charge to our condensed consolidated statement of operations and $1.6 million in
deferred revenue to our balance sheet. (See Note 2 of Notes To Condensed Consolidated Financial Statements.)





Liquidity and Capital Resources





We have funded our operations to date primarily through the public offerings of our common stock. As of December 31, 2001,
our principal source of liquidity included cash, cash equivalents and short-term investments of $32.4 million. We currently do not have a line of credit facility.





Operating Activities





Our operating activities generated
$3.6 million of cash for the three months ended December 31, 2001. The cash provided by operating activities was primarily due to increases in our accounts payable and the non-cash charge for depreciation and amortization and the non-cash charge for
acquired in-process research and development. The cash provided by operations was partially offset by cash used to support our regular operating activities and increased inventory purchases.





Our operating activities used $2.9 million of cash for the three months ended December 31, 2000. The cash used in operating activities was primarily due to supporting our regular
operating activities as well as an increase in inventories, accounts receivable, and other current assets, partially offset by increases in deferred revenue and other liabilities.





Investing Activities





Our investing activities used $7.0
million of cash for the three months ended December 31, 2001 primarily due to our acquisition of Cayman in October 2001, our purchase of furniture, fixtures and equipment partially offset by proceeds realized from the sale and maturity of short-term
investments.




17




---




Cash provided by investing activities of $2.5 million for the three months ended December 31,
2000 was primarily due to proceeds from the sale and maturity of short-term investments, partially offset by purchases of short-term investments, our investment in Megapath Networks, and purchases of furniture, fixtures and equipment.





During the three months ended December 31, 2000, we purchased $2.0 million of Series D Preferred stock in MegaPath. MegaPath offers
high-speed DSL access and eCommerce and Web hosting services to small and medium size businesses. During fiscal year 2000, MegaPath had purchased our broadband Internet equipment and licensed certain of our Web platform products. Although there is
no public market for MegaPaths stock, we believe the market value of these shares is not less than $2.0 million.





Financing Activities





Our financing activities provided $0.2 million and $0.1 million for the three months ended
December 31, 2001 and 2000, respectively, primarily due to the exercise of employee stock options.





We currently depend on our
existing cash, cash equivalents and short-term investments of $32.4 million to meet our needs for working capital and believe such amount will be adequate to meet our cash needs for working capital and capital expenditures for the next twelve
months. We do not have a line of credit facility nor do we utilize any off-balance sheet financing arrangements. We may require additional capital to finance our future growth and fund our ongoing research and development activities during fiscal
2002 and beyond. If we issue additional stock to raise capital, the percentage ownership in Netopia of our existing stockholders would be reduced. Additional financing may not be available when needed and, if such financing is available, it may not
be available on terms we believe favorable.





From time to time, in the ordinary course of business, we may evaluate potential
acquisitions of businesses, products and technologies. Accordingly, a portion of our cash may be used to acquire or invest in complementary businesses or products, to obtain the right to use complementary technologies, to obtain additional presence
on the Internet or to support additional advertising and promotional campaigns. In the past, our acquisitions and divestitures have involved numerous risks, including the use of significant amounts of our cash, diversion of the attention of our
management from our core business, loss of our key employees and significant expenses and write-offs. For example, in December 1998, we acquired netOctopus and Serus, in October 1999, we acquired StarNet, in March 2000, we acquired WebOrder and in
October 2001, we acquired Cayman. The success of these acquisitions depend upon our ability to retain the customers and employees acquired and timely and successfully develop, manufacture and gain market acceptance for the products acquired. If we
engage in additional acquisitions or divestitures in future periods, we may not be able to adequately address these risks and our business may be harmed.





Risk Factors





In addition to other information in this Form 10-Q, the following risk factors should be
considered carefully in evaluating our business because such factors currently may have a significant impact on our business, operating results and financial condition. As a result of the risk factors set forth below and elsewhere in this Form 10-Q,
and the risks discussed in our other filings with the SEC, actual results could differ materially from those projected in any forward-looking statements.





Substantial sales of our broadband Internet equipment will not occur unless telecommunications carriers initiate substantial deployment of DSL services.





The success of our broadband Internet equipment depends upon whether telecommunications carriers deploy DSL and other broadband technologies and upon the timing of the deployment of
such technologies. Factors that will impact such deployment include:





| |  |  | A prolonged approval process by service providers, including laboratory tests, technical trials, marketing trials, initial commercial deployment and full commercial deployment;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | The development of a viable business model for DSL and other broadband services, including the capability to market, sell, install and maintain DSL and other broadband
services;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



18




---




| |  |  | The ability of our CLEC customers to obtain required capital resources;
| | - |  | -----------------------------------------------------------------------




| |  |  | Cost constraints, such as installation costs and space and power requirements at the telecommunications service providers central office;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------




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




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




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




Demand for
DSL services has exceeded the ability of telecommunications carriers and ISPs to deploy services in a timely manner and to provide satisfactory customer service. We offer to carriers and service provider customers the opportunity to bundle basic DSL
connectivity with value-added features that enable the provider to bundle differentiated services that will justify higher recurring revenues from end users. These features include dial backup, VPN, voice over DSL and eSite or eStore hosting. We can
offer no assurance that our strategy of enabling bundled service offerings will be widely accepted. If telecommunications carriers do not expand their deployment of DSL and other broadband services, or if additional telecommunications carriers do
not offer DSL and other broadband services on a timely basis, then our business, financial condition and results of operations will be seriously harmed.





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





ILECs have been aggressively marketing DSL services principally focusing on residential services.
Historically, we have not sold meaningful quantities of our broadband Internet equipment to ILECs in the United States. As a result of our acquisition of Cayman, we have expanded the channels through which we sell our products to include ILEC
customers, such as SBC and BellSouth and Comcast, a cable provider, and have committed resources that are focused on expanding our presence in the ILEC channel both domestically and internationally in response to changing market conditions. There
continue to be barriers associated with such sales including, but not limited to, lengthy product evaluation cycles, the ability to dislodge competitors whose products are currently being utilized, a long-term contract cycle and intense price
pressures. ILECs currently obtain equipment from our competitors, such as Siemens (Efficient Networks and its FlowPoint product line), ZyXEL and 2Wire, who have proven to be strong competitors. There is no guarantee we will be successful in
retaining the customers acquired in connection with our acquisition of Cayman or our ability to successfully expand our presence in the ILEC market. If we fail to retain the customers acquired in connection with our acquisition of Cayman or fail to
successfully penetrate the ILEC market for our products and services, our business may be materially and adversely affected.





The DSL market, and the channel through which we historically have sold our DSL products, has experienced significant business difficulties during the past year, which have negatively affected our business and operating results.





Prior to our acquisition of Cayman in October 2001, our most significant customers have been CLECs and ISPs. Since the
middle of calendar year 2000, CLECs have experienced significant business difficulties due to an inability to obtain financing to continue to build out their networks. The difficulties of these customers have materially and adversely affected our
operating results, causing a significant decline in the price of our common stock. During the last twelve months, three of our CLEC customers, Covad, Rhythms, and Northpoint have demonstrated the following market difficulties:





| |  |  | Covad, our largest customer in fiscal year 2001, has reduced its breadth of network build-out and significantly scaled back its operations. In addition, Covad filed a voluntary
petition under the Bankruptcy Act in August 2001 as part of a capital restructuring plan. On November 13, 2001, Covad announced that it had secured an agreement with SBC to provide Covad with $150 million in funding. Covad announced on December 13,
2001 that it received approval of its reorganization plan from the Bankruptcy Court and emerged from bankruptcy on December 20, 2001 upon closing the SBC funding.Additionally, Covad has announced that this funding is expected to provide the cash
that it believes will allow it to become cash flow positive by the latter half of 2003;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



19




---




| |  |  | Rhythms announced in January 2001 its intention to reduce the number of markets in which it offers services and significantly scaled back its operations. In addition, Rhythms
filed a voluntary petition under the Bankruptcy Act in August 2001, and ceased normal operations during September 2001. In December 2001, WorldCom purchased Rhythms key DSL assets. As a result, WorldCom will be able to deliver uninterrupted
service to existing Rhythms customers served by the portion of the network that WorldCom is acquiring. However, there is no certainty that WorldCom will continue to purchase our equipment for deployment on the Rhythms network; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Northpoint voluntarily filed for protection under the Bankruptcy Act in January 2001 and subsequently ceased operations during March 2001.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------




Like the CLECs, ISPs also have struggled in the past year. Most ISPs have had significant difficulties in differentiating their services from
the services provided by their competitors. As a result, the lack of differentiation has led to significant erosion in the prices charged to customers. Many of our ISP customers such as Mpower Communications, PSINet, Onsite Access and Business
Telecommunications, have all experienced business difficulties and some have filed for bankruptcy or ceased operations. PSINet, which had been one of our key ISP customers for the past three years, filed a voluntary petition under the Bankruptcy Act
in June 2001, and most of its Canadian subsidiaries filed for protection under similar Canadian statutes. The pricing pressure for ISPs continues to date, and, accordingly, sales of our products to ISPs remain difficult. The financing market for
CLECs and ISPs has remained difficult and has been largely closed in calendar year 2001 and the beginning of calendar year 2002, resulting in significantly decreased sales to CLECs and ISPs and write-offs of outstanding accounts receivable.





If we are unable to retain the customers and/or employees and complete the projects acquired in connection with our
acquisition of Cayman, our business would be seriously harmed.





We have attempted to expand the channels through which and
markets to which we sell our products through our acquisition of Cayman, a privately held developer and supplier of business class broadband gateways consisting primarily of ADSL and cable Ethernet routers. Previously, we had focused on serving the
small and medium size business market primarily through the CLEC channels through which we have historically derived a substantial portion of our revenue. The Cayman acquisition expanded our customer base to include Caymans existing base of
ILEC customers, such as SBC and BellSouth, and Comcast, a leading cable provider. If we are unable to retain the customers and/or employees acquired, maintain the quality of the products we acquired and timely and successfully develop, manufacture
and gain market acceptance of the products which were under development at the time of the acquisition, our business will be seriously harmed. The Cayman acquisition has involved numerous risks, including the use of significant amounts of our cash,
diversion of the attention of our management from our core business and significant expenses and write-offs. Incremental acquisition related charges including in-process research and development will adversely impact our profitability. Additionally,
we may have to record additional acquisition related charges, including the impairment of goodwill, which would adversely impact our profitability. (See Note 6 of Notes to Consolidated Financial Statements.)





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





Our revenues will decline and we may incur losses if we lose one or more of our significant customers or if our customers
reduce or delay purchases of our products. For the three months ended December 31, 2001, there were four customers who each individually represented at least 5% of our revenues and in the aggregate, accounted for 39% of our total revenues. For
fiscal year 2001, our top three customers who each individually represented at least 5% of our total revenues, accounted for approximately 38% of our total revenues. In this period, sales to Covad, Ingram Micro and Rhythms represented approximately
16%, 11% and 11%, respectively, of our total revenues. Covad has incurred operating losses and negative cash flows as it establishes its network and operations. Accordingly, Covad is dependent on continued access to new sources of capital. As a
result, Covad filed a voluntary petition under the Bankruptcy Act in August 2001 as part of a capital restructuring plan. On November 13, 2001, Covad announced that it had secured an agreement with SBC to provide Covad with $150 million in funding.
Covad announced on December 13, 2001 that it received approval of its reorganization plan from the Bankruptcy Court and emerged from bankruptcy on December 20, 2001 upon closing the SBC funding. Additionally, Covad has announced that this funding is
expected to provide the cash that it believes will allow it to become cash flow positive




20




---

by the latter half of 2003. Additionally, Rhythms, which had been an important customer, filed a voluntary petition under the Bankruptcy Act in August 2001, and ceased normal operations during
September 2001. In December 2001, WorldCom purchased Rhythms key DSL assets. As a result, WorldCom will be able to deliver uninterrupted service to existing Rhythms customers served by the portion of the network that WorldCom is acquiring.
However, there is no certainty that WorldCom will continue to purchase our equipment for deployment on the Rhythms network.





We have a history of losses and negative cash flow from operations. We may incur losses and negative cash flow from operations in the future.





Our failure to significantly increase our revenues or sufficiently reduce our operating expenses will result in continuing losses. We incurred losses from continuing operations of $6.1 million for the three months
ended December 31, 2001 and have incurred losses from continuing operations of $41.7 million, $17.6 million and $7.9 million for fiscal years 2001, 2000 and 1999, respectively. Our operations provided $3.6 million of cash for the three months ended
December 31, 2001 and have used $5.8 million of cash for fiscal year 2001, provided $0.1 million of cash for fiscal year 2000 and used $8.4 million of cash for fiscal 1999. Even if we reach profitability and maintain positive cash flow from
operations, we may not be able to sustain or increase profitability or cash flow from operations on a quarterly or annual basis.





We may incur negative cash flow in the future particularly to the extent we complete any acquisition opportunities. As a result of continuing substantial capital expenditures and product development, sales, marketing and administrative
expenses, we will need to generate significant revenues to maintain positive cash flow from operations.





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. 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.





It is likely that
in some future quarter or quarters our operating results will be below the expectations of securities analysts or investors. In such event, the market price of our common stock may decline significantly. Variations in our operating results will
likely be caused by factors related to the operation of our business, including:





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




| |  |  | Decreases or delays in purchases by significant customers, or loss of customers such as Covad, Ingram Micro, SBC, BellSouth or Comcast;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------




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




| |  |  | Our ability to license, and the timing of licenses, of our Web platform products;
| | - |  | ---------------------------------------------------------------------------------




| |  |  | The growth rate in the number of eSites and eStores that are built using our Web platform products from which we derive revenues;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------




| |  |  | 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
Internet equipment products as a percentage of our total revenues and increased sales of lower margin ADSL products within our family of broadband Internet equipment products.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Shifts in the channel fulfilling demand from small, medium and distributed enterprises for DSL services to entities with whom we do not have historical relationships;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | The price and availability of chip sets for our DSL routers and IADs;
| | - |  | ---------------------------------------------------------------------




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



21




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| |  |  | Our ability to attract and retain key personnel.
| | - |  | ------------------------------------------------




These variations may also be caused by factors related to the development of the market for broadband Internet equipment, the market for our Web platform products and the competition we face in these markets,
including:





| |  |  | The ability of CLECs to obtain required capital resources;
| | - |  | ----------------------------------------------------------




| |  |  | The timing, rate and ability of telecommunications service providers to deploy DSL and other broadband services;
| | - |  | ----------------------------------------------------------------------------------------------------------------




| |  |  | Anticipated price and promotion competition in the market for broadband Internet equipment and Web platform products;
| | - |  | ---------------------------------------------------------------------------------------------------------------------




| |  |  | The level of market penetration of our broadband Internet equipment and Web platform products relative to those of our competitors;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------




| |  |  | The timing and rate of deployment of alternative high-speed data transmission technologies, such as cable and high-speed wireless data transmission; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Anticipated increases in competition among producers of eCommerce products, including the impact of products that are available from some of our competitors at no cost.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------




These variations may also be caused by other factors affecting our business, many of which are substantially
outside of the control of our management, including:





| |  |  | Foreign currency and exchange rate fluctuations which may make our dollar-denominated products more expensive in those foreign markets where we sell our products in United
States dollars or could expose us to currency rate fluctuation risks to the extent we do not adequately hedge these foreign currency sales;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Costs associated with future litigation, including securities litigation or litigation relating to the use or ownership of intellectual property;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Acquisition costs or other non-recurring charges in connection with the acquisition of companies, products or technologies; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------




| |  |  | General global economic conditions that could adversely affect sales to our customers.
| | - |  | --------------------------------------------------------------------------------------




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





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





In the market for broadband Internet equipment, we primarily compete with Cisco, Siemens (Efficient Networks and its FlowPoint product line), Lucent, Linksys, 2Wire, Polycom (in the IAD market), and ZyXEL.





In the market for our Web platform products, we primarily compete with Trellix, Web Site Pros, Big Step, Nextron, Computer Associates, Intel, Microsoft,
Vector Networks, Stac Software, Symantec, and Tivoli Systems (IBM). We anticipate intense competition from some of these companies because some of these competitors provide their products to consumers at no cost. For example, Microsoft has available
at no cost a communications and collaboration software product that could limit the market for our Timbuktu Pro product.





Many
of our current and potential competitors in all product areas have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger base of customers than we
do. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge of these industries. In the past, we have lost potential customers to competitors in all product areas
for various reasons, including lower prices and other incentives not




22




---

matched by us. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their
products and services to address customer needs. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of industry
consolidation.





Our limited operating history in broadband gateways makes it difficult to evaluate our prospects.





Our broadband Internet equipment products are relatively new. These products are at an early stage of development in a
relatively new, rapidly evolving and intensely competitive market. We may not correctly anticipate market requirements, including requirements for performance, price, features and compatibility with other broadband equipment. We may not be able to
rapidly introduce innovative new products that meet these market requirements. It is possible that the market for broadband Internet equipment products will develop in a manner that we do not anticipate. Our competitors have already introduced
broadband products, some of which may compete effectively against our broadband Internet equipment products. Such developments could render our broadband Internet equipment products obsolete.





Sales of our DSL Internet equipment will decline substantially if central office DSL equipment is not widely deployed.





We currently depend on the central office equipment of telecommunications carriers that are deploying DSL services. Historically, substantially all of our sales of DSL routers have
been designed, manufactured and sold for use with DSL central office equipment manufactured by Copper Mountain and Nokia. We have introduced DSL routers that are interoperable with Alcatel, Cisco, Ericsson, Lucent, Nortel, Orckit, Paradyne, Siemens,
and Zhone central office access concentrators. If DSL central office equipment with which our routers are interoperable are not widely used in DSL deployments, our business will be seriously harmed.





The market for integrated voice and data products and combined services may not grow as anticipated.





We have released a new line of IADs designed to allow for voice and data services over a single DSL line. Our future growth is substantially dependent
on the widespread deployment of these integrated voice and data products for combined voice and data services. To date, service providers, including ILECs and CLECs, have not deployed such combined services broadly and the market has grown more
slowly than anticipated. Unless such products and services are broadly deployed, our integrated voice and data products and combined services may not have a meaningful commercial impact, which could result in significant variations in our future
operating results





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





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





We purchase the semiconductor chips for our DSL routers from a limited number of suppliers.





All of our DSL routers rely on special semiconductor chips that we purchase from a limited number of suppliers. We do not have volume purchase contracts with any of our suppliers and
they could cease selling us these semiconductor chips at any time. If we are unable to timely obtain a sufficient quantity of these semiconductor chips from any of our suppliers, for any reason, sales of our DSL routers could be delayed or halted.
Further, we could also be forced to redesign our DSL routers and qualify new suppliers of semiconductor chip sets. The resulting stoppage or delay in selling our products and the expense of redesigning our DSL routers would seriously harm our
reputation and business.




23




---




Substantially all of our circuit boards are manufactured by a limited number of contract
manufacturers.





Substantially all of our broadband Internet equipment includes circuit boards that are manufactured by a
limited number of contract manufacturers. Additionally, certain of our broadband Internet equipment products are assembled and packaged by these contract manufacturers. If supplies of circuit boards or broadband Internet equipment products from
these contract manufacturers are interrupted for any reason, we will incur significant losses until we can arrange for alternative sources. Any such interruption may seriously harm our reputation and business.





We may be unable to obtain components for our broadband Internet equipment from independent contractors and specialized suppliers.





We do not manufacture any of the components used in our products and perform only limited assembly on some products. All of our broadband
Internet equipment relies on components that are supplied by independent contractors and specialized suppliers. We generally 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 Internet equipment also depends on our ability to accurately forecast our future requirements. If we are
unable to timely obtain a sufficient quantity of components from independent contractors or specialized suppliers for any reason, sales of our broadband Internet equipment could be delayed or halted. 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 Internet equipment and qualify new suppliers of components. The resulting stoppage or delay in selling our products and the expense of redesigning our
broadband Internet equipment would seriously harm our reputation and business. In addition, we anticipate that it will be necessary for us to establish relationships with additional component suppliers in the future. If we are unsuccessful in
establishing these relationships, we may not be able to obtain sufficient components in some future period.





We need
to develop, introduce and market new and enhanced products in a timely manner to remain competitive.





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 that provide increasingly higher
levels of performance, reliability and compatibility. We will need to continue to integrate our DSL router technology with the architectures of leading central office equipment providers in order to enhance the reliability, ease-of-use and
management functions of each of our DSL products. Currently, our router products are fully integrated with Copper Mountain central office access concentrators and are interoperable with Alcatel, Cisco, Ericsson, Lucent Technologies, Nortel, Nokia,
Orckit, Paradyne, Siemens, and Zhone central office access concentrators. However, we may not be able to successfully develop, introduce, enhance or market these or other products 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 Internet
equipment products 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 relatively new, rapidly evolving and intensely competitive
market. For example, we may not correctly anticipate market requirements, including requirements for performance, price, features and compatibility with other DSL equipment. We may not be able to introduce rapidly innovative new products that meet
these market requirements. It is possible that the market for broadband Internet equipment will develop in a manner that we do not anticipate.





We may engage in acquisitions or divestitures that involve numerous risks, including the use of cash and the diversion of management attention.





In the past, we have engaged in both acquisitions and divestitures. For example, in December 1998, we acquired netOctopus and Serus, in October 1999, we acquired StarNet, in March 2000,
we acquired WebOrder, and in October 2001, we acquired Cayman. We also entered into an agreement and plan of reorganization in January 2001




24




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under which we agreed to be acquired by Proxim. This agreement was mutually terminated in March 2001. In addition, in August 1998, we sold our LAN Division. We may continue to acquire companies,
technologies or products or to sell or discontinue some of our technologies or products in future periods. In the past, our acquisitions and divestitures have involved numerous risks, including the use of significant amounts of our cash, diversion
of the attention of our management from our core business, loss of our key employees and significant expenses and write-offs. In September 2001, for example, we recorded a $16.4 million charge for impairment of goodwill and other intangible assets
related to our acquisitions of WebOrder, StarNet and Serus. Incremental acquisition related charges including in-process research and development and amortization of goodwill and other intangibles or divestitures of profitable technologies or
products could adversely impact our profitability. The success of these acquisitions depends upon our ability to retain the customers and key employees, and timely and successfully develop, manufacture and gain market acceptance for the products we
acquired. If we engage in additional acquisitions or divestitures in future periods, we may not be able to address these risks and our business may be harmed.





Our revenues will not grow and we may incur losses if we cannot successfully introduce, market and sell our Web platform products.





The majority of our Web platform revenues are derived from the sale of Timbuktu Pro. We anticipate that the market for Timbuktu Pro will grow more slowly than the market for our other
Web platform products and services. In addition, we rely on licensees of our Web platform to promote the use of our Web platform for building eSites and eStores. The extent and nature of the promotions by licensees of our Web platform are outside of
our control. If licensees of our Web platform do not successfully promote our Web platform, we will not generate recurring revenues from royalties on eSites and eStores promoted by licensees of our Web platform.





To be successful, use of our Web platform must become widespread, and this will require us to expand our sales and distribution channels, which we
may be unable to do.





Growth in revenues from our Web platform will be heavily dependent on recurring fees from eSites and
eStores created by licensees. Accordingly, to be successful, our Web platform must become widely used. If we are unable to expand our sales and distribution channels to establish the widespread use of our Web platform, it is possible that competing
products could become widely used, reducing the likelihood that we will generate significant revenues from our Web platform. In addition, some companies are offering Web presence and enhancement products at no cost. If such free products and
services become widely used, the market for our Web platform products will be limited.





If hosting services for our
Web platform perform poorly, our reputation will be damaged 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 eSite and eStore hosting services for our customers. In addition, our servers are located at third-party facilities.
Failure or poor performance by third parties with whom we contract to maintain our servers, hardware and software, could lead to interruption or deterioration of our eSite and eStore hosting services. Additionally, a slowdown or failure of our
systems due to an increase in the use of the eSites and eStores we currently host, or due to damage or destruction of our systems for any reason, or the possibility of rolling blackouts could also lead to interruption or deterioration of our eSite
and eStore hosting services. If there is an interruption or a deterioration of our eSite and eStore hosting services, our reputation would be seriously harmed and, consequently, sales of our products and services would decrease. If such
circumstances do arise in some future period, in order to retain current customers and attract new customers, we may have to provide our eSite and eStore hosting services at a subsidized price or even at no cost. In addition, if our eSite and eStore
hosting services are interrupted, perform poorly, or are unreliable, we are at risk of litigation from our customers.





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





We expect that sales of our broadband Internet equipment may account for a larger percentage of our total revenues in future periods. Because these products are generally sold at lower
gross margins than our Web platform products, this will likely result in a decrease in our overall gross margins. Further, we expect that the market for




25




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broadband Internet equipment, in particular DSL products, will become increasingly competitive and that we will be forced to lower the prices we charge for our broadband Internet equipment in the
future. As the average selling price of our routers declines, our gross margins related to such products, as well as our overall gross margins, are likely to decline.





We derive a substantial portion of the recurring revenues from our Web platform products from a small number of large customers.





We derive a substantial portion of the recurring revenues from our Web platform products from a small number of large customers. If these customers were
to choose a competitive platform or are unable to market the platform successfully to their customers, this could lead to reduced revenues and adversely impact our results.





Our Web platform products have a lengthy sales cycle.





We
derive a substantial portion of our Web platform revenue from a small number of customers, and the sales cycle for licenses of Web platform products may be long. Licenses of Web platform products are typically closed in the final weeks of the
quarter and the timing of these licenses may cause our quarterly results to vary. Our inability to obtain customer commitments or delays in such commitments due to the lengthy sales cycles would reduce our revenues and adversely impact our results.





A substantial portion of our revenues are derived from sales to international customers.





A substantial portion of our revenues is derived from sales to European and other international customers. We expect sales to international customers to
continue to comprise a significant portion of our revenues. In the past, our international sales have typically been denominated in United States dollars. Beginning in our fiscal third quarter of 2000, sales of broadband Internet equipment products
to our European customers who are members of the European Union have been denominated in the Euro. All other international sales will continue to be denominated in United States dollars. 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. This could lead to decreased profitability of our products and services. In addition,
changes in the value of the Euro relative to the United States dollar could adversely affect our operating results to the extent we do not hedge sales denominated in the Euro.





There are risks associated with international operations.





Our international operations are subject to a number of difficulties and special costs, including:





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




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




| |  |  | Dependence on local vendors
| | - |  | ----------------------------




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




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




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




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




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




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




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




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



26




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We must also customize our products for local markets. Further, if we establish significant
operations overseas, we may incur costs that would be difficult to reduce quickly because of employee-related laws and practices in those countries.





We typically experience a seasonal reduction in revenues in the three months ended September 30.





In the past, we have experienced a seasonal reduction in our revenues in the three months ended September 30, our fiscal fourth quarter, primarily due to European vacation schedules that typically result in reduced economic activity in
Europe during such periods. We anticipate that this trend will continue.





Our success depends on retaining our current key
personnel and attracting additional key personnel.





Our future performance depends on the continued service of our senior
management, product development and sales personnel, particularly Alan Lefkof, our President and Chief Executive Officer, Thomas Skoulis, our Senior Vice President and General Manager, Web Platforms and Michael Trupiano, our Senior Vice President
and General Manager, Internet Equipment. None of these persons is bound by an employment agreement, and we do not carry key person life insurance. The loss of the services of one or more of our key personnel could seriously harm our business. Our
future success depends on our continuing ability to attract, hire, train and retain a substantial number of 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. Competition for qualified personnel is intense, and we may fail to retain our key employees or to attract or retain other highly qualified personnel.





Our intellectual property may not be adequately protected, and our products may infringe upon the intellectual property rights of third parties.





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.





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.





For example, in selling our Timbuktu Pro software, we often rely on license cards that are included in our products and are not signed by licensees. Therefore, such licenses may be
unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries where our products are or may be manufactured or sold, particularly developing countries including various countries in Asia, such as the
Peoples Republic of China, do not protect our proprietary rights as fully as do the laws of the United States.





We may
not be able to license necessary software, firmware and hardware designs from third parties.





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 to perform key functions. 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 shipment delays or reductions until equivalent firmware is developed, identified, licensed and integrated
which would seriously harm our business.





Our customers may return our products to us for replacement or refund.





We provide end users of our products with a two-year limited warranty on our broadband Internet equipment and a 90-day
limited warranty on single-user versions of our Timbuktu Pro software. We permit end users to return our broadband Internet equipment and Timbuktu Pro for replacements or for refund of the full purchase price if the products do not perform as
warranted. Our other Web platform products are provided on an as is basis, and we




27




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generally do not offer a warranty on this product. End users of our eSites and eStores generally can discontinue their service at any time at no cost. In the past, we have not encountered
material warranty claims. In the future, if warranty claims exceed our reserves for such claims, our business would be seriously harmed. Additionally, we attempt to further limit our liability to end users through disclaimers of special,
consequential and indirect damages and similar provisions. However, we cannot assure you that such limitations of liability will be legally enforceable.





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. We cannot assure you that, despite our testing, defects will not be found in new products or new versions of products following
commercial release. 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. In addition, we would be at risk of product
liability litigation for financial or other damages to our customers because of defects in our products. Although we attempt to limit our liability to end users through disclaimers of special, consequential and indirect damages and similar
provisions, we cannot assure you that such limitations of liability will be legally enforceable.





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





We have a limited number of stockholders that
hold a large portion of our common stock. To the extent our large stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could fall.





Our industry may become subject to changes in tariffs and regulations.





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





Business interruptions could adversely affect our
business.





Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure 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, we do not carry sufficient business interruption insurance to compensate us for losses that may occur and any losses or damages incurred by us could have a material
adverse effect on our business.





We may find it difficult to raise needed capital in the future, which could significantly
harm our business.





We may require substantial capital to finance our future growth and fund our ongoing research and
development activities. Our capital requirements will depend on many factors, including:





| |  |  | Acceptance of and demand for our products;
| | - |  | ------------------------------------------




| |  |  | The number and timing of acquisitions;
| | - |  | --------------------------------------




| |  |  | The costs of developing new products;
| | - |  | -------------------------------------




| |  |  | The costs associated with expansion; and
| | - |  | ----------------------------------------




| |  |  | The extent to which we invest in new technology and research and development projects.
| | - |  | --------------------------------------------------------------------------------------



28




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If we issue additional stock or other instruments to raise capital, the percentage ownership in
Netopia of existing stockholders would be reduced. Additional financing may not be available when needed and, if such financing is available, it may not be available on terms favorable to us.





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 the following factors, some of which are beyond our control:





| |  |  | Variations in our quarterly operating results;
| | - |  | ----------------------------------------------




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




| |  |  | Changes in market valuations of similar companies;
| | - |  | --------------------------------------------------




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




| |  |  | Losses of major customers, major projects with major customers or the failure to complete significant licensing transactions;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------




| |  |  | Additions or departures of key personnel;
| | - |  | -----------------------------------------




| |  |  | Fluctuations in the stock market price and volume, which are particularly common among highly volatile securities of companies in our industry;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | General conditions in the broadband communications industry, in particular the DSL market, or the domestic and worldwide economies;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------




| |  |  | Decreases or delays in purchases by significant customers;
| | - |  | ----------------------------------------------------------




| |  |  | A shortfall in revenue or earnings from securities analysts expectations or other announcements by securities analysts;
| | - |  | ------------------------------------------------------------------------------------------------------------------------




| |  |  | Our ability to protect and exploit our intellectual property or defend against the intellectual property rights of others; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------




| |  |  | Developments in our relationships with customers, distributors and suppliers.
| | - |  | -----------------------------------------------------------------------------




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, including fluctuations that are unrelated to our
performance.





We are at risk of securities class action litigation due to the expected volatility of our stock price.





In the past, securities class action litigation has often been brought against a company following periods of volatility in
the market price of its securities. In the future, we may be a target of similar litigation. Securities litigation could result in substantial costs and divert managements attention and resources.





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.




29




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PART I.    FINANCIAL INFORMATION





ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Our
exposure to market risk for changes in interest rates relates primarily to our investment portfolio. Our exposure to foreign exchange risk relates primarily to sales made to international customers denominated in Euros. We do not use derivative
financial instruments for speculative or trading purposes. We place our investments in instruments that meet high credit quality standards, as specified in our investment policy. This policy also limits the amount of credit exposure to any one
issue, issuer and type of instrument. We do not expect any material loss with respect to our investment portfolio. Beginning in our fiscal third quarter of 2000, sales to European countries that are members of the European Union have been
denominated in the Euro. In order to reduce our exposure resulting from currency fluctuations, we have entered into currency exchange forward contracts. These contracts guarantee a predetermined exchange rate at the time the contract is purchased.
We do not enter into currency exchange contracts for speculative or trading purposes.





Interest Rate Risk





The table below presents the market value and related weighted-average interest rates for our investment portfolio at December 31, 2001 and 2000. All of
our investments mature in twelve months or less.





December 31, 2001


December 31, 2000Principal (notional) amounts in United States dollars:

Cost basis

Fair market value

Average interest rate


Cost basis

Fair market value

Average interest rate(in thousands)




(in thousands)Cash equivalents  fixed rate(a)

$
30,141

$
30,176

1.93
%

$
36,171

$
36,355

6.41
%Short-term investments  fixed rate(b)











15,644


15,893

6.50
%$
30,141

$
30,176




$
51,815

$
52,248


---

|(a) |  | Cash equivalents represent the portion of our investment portfolio that mature in less than 90 days.
|--- |  | ----------------------------------------------------------------------------------------------------

|(b) |  | Short-term investments represent the portion of our investment portfolio which mature in greater than or equal to 90 days.
|--- |  | --------------------------------------------------------------------------------------------------------------------------




Our market interest rate risk relates primarily to changes in the United States short-term prime interest rate. These changes impact the price and yield
of our short-term investments. We minimize this risk by following a policy of portfolio diversification.





Foreign Currency Exchange Risk





The table below presents the carrying value, in United
States dollars, of our accounts receivable denominated in Euros at December 31, 2001 and 2000. These accounts receivable are valued at the United States/Euro exchange rate as of December 31, 2001. The carrying value approximates fair value at
December 31, 2001 and 2000.





December 31, 2001

December 31, 2000Principal (notional) amounts in United States dollars:

Carrying amount

Exchange rate

Carrying amount

Exchange rate(in thousands)



(in thousands)Accounts receivable denominated in Euros

$
1,411

0.8915

$
2,421

0.9424




30




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The table below presents the carrying value of our currency exchange forward contracts, in
United States dollars, at December 31, 2001 and 2000. The carrying value approximates fair value at December 31, 2001 and 2000.





December 31, 2001

December 31, 2000Principal (notional) amounts in Euros:

Carrying amount

Spot rate

Settlement date

Carrying amount

Spot rate

Settlement date(in thousands)





(in thousands)Currency exchange forwardcontract # 1

$
44

0.8904

January 2002

$
729

0.8576

January 2001Currency exchange forwardcontract # 2

$
223

0.8743

January 2002

$
773

0.8586

February 2001Currency exchange forwardcontract # 3

$
131

0.8728

February 2002

$
620

0.8857

March 2001





Our foreign currency exchange risk relates to changes in the value of the Euro
relative to the United States dollar. We manage this risk by entering into currency exchange forward contracts. These contracts guarantee a predetermined exchange rate at the time the contract is purchased.





PART II.    OTHER INFORMATION





ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K





(a)  Exhibits





Exhibit Number

Description10.12

Netopia, Inc. 2002 Equity Incentive Plan; as adopted by the Netopia Board of Directors on December 13, 2001 and approved by the
Netopia shareholders on January 30, 2002.





(b)  During the three months ended December 31, 2001, we filed the
following reports on Form 8-K:





| |  |  | On October 17, 2001, we filed a report on Form 8-K reporting: Item 2  Acquisition or Disposition of Assets; and Item 7  Financial Statements and Exhibits,
announcing the completion of the Cayman acquisition. Although there were no financial statements filed as part of this Form 8-K, we stated that we would provide the financial statements and pro forma financial information required by Item 7 of Form
8-K within 60 days of the date that the Form 8-K is required to be filed with the United States Securities and Exchange Commission.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | On November 6, 2001, we filed a report on Form 8-K reporting: Item 5  Other Events, announcing the appointment of Bob Lee as a member of our Board of Directors; and Item
7  Financial Statements and Exhibits, which included as an exhibit, the press release dated November 6, 2001 announcing Mr. Lees appointment.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | On December 21, 2001, we filed a report on Form 8-K reporting: Item 7  Financial Statements, Pro Forma Information and Exhibits, which included the audited financial
statements and related documents of Cayman Systems, Inc. as well as the required unaudited pro forma financial information relating to the Cayman acquisition.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURE





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





Date:February 14, 2002

NETOPIA, INC. (Registrant)By:

/S/    WILLIAM D.
BAKERWilliam D. Baker Senior Vice President and Chief Financial
Officer




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