<PAGE>

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-Q

(Mark One)

             [X] Quarterly Report Pursuant to Section 13 or 15(d)
                    Of The Securities Exchange Act of 1934

                       For Quarter Ended March 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 001-15715


                               NETPLIANCE, INC.


                      Organized in the State of Delaware
                       Tax Identification No. 74-2902814

          7501B North Capital of Texas Highway, Austin, Texas  78731
                         Telephone No. (512) 681-8300


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

          The number of shares outstanding of each of the issuer's classes of
common stock as of April 30, 2001.

                Class                             Number of Shares
                -----                             ----------------
     Common Stock, $0.01 par value                   60,632,647
<PAGE>

                               NETPLIANCE, INC.

                                    INDEX
<TABLE>
<CAPTION>


                                                                                    Page
                                                                                   Number
                                                                                   ------
<S>             <C>                                                                <C>

PART I.      FINANCIAL INFORMATION:...........................................          1

  Item 1.    Financial Statements (unaudited).................................          1

             Condensed Balance Sheets
                as of March 31, 2001 and December 31, 2000....................          1

             Condensed Statements of Operations
                for the three months ended March 31, 2001 and 2000...............       2

             Condensed Statements of Cash Flows
                for the three months ended March 31, 2001 and 2000...............       3

             Notes to Condensed Financial Statements.............................       4

  Item 2.    Management's Discussion and Analysis of Results of Operations and
                Financial Condition..............................................       9

  Item 3.    Quantitative and Qualitative Disclosure About Market Risk...........      23

PART II.     OTHER INFORMATION:..................................................      23

  Item 1.    Legal Proceedings...................................................      23

  Item 6.    Exhibits and Reports on Form 8-K....................................      24

  Signatures.....................................................................      25
</TABLE>
<PAGE>

PART I.  FINANCIAL INFORMATION.

ITEM 1.  FINANCIAL STATEMENTS.

                                NETPLIANCE, INC.
                            CONDENSED BALANCE SHEETS
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                     March 31,           December 31,
                                ASSETS                                                 2001                   2000
                                                                                   ------------          ------------
<S>                                                                                <C>                   <C>

Current assets:
     Cash and cash equivalents and short-term investments..............            $ 59,299,993          $ 68,123,618
     Prepaid expenses..................................................                 728,264               290,583
     Other.............................................................                 231,331               627,357
                                                                                   ------------          ------------

         Total current assets..........................................              60,259,588            69,041,558
                                                                                   ------------          ------------

Property and equipment, net............................................               6,094,119             6,774,182
Net assets from discontinued operations................................                       -             8,195,579
Other..................................................................               2,343,121             2,309,277
                                                                                   ------------          ------------

                                                                                   $ 68,696,828          $ 86,320,596
                                                                                   ============          ============

                   LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
     Trade accounts payable............................................            $    374,320          $  1,284,948
     Accrued liabilities...............................................               5,669,116            13,382,685
     Current portion of capital lease obligations......................                 376,383               637,873
                                                                                   ------------          ------------
         Total current liabilities.....................................               6,419,819            15,305,506
                                                                                   ------------          ------------
Net liabilities from discontinued operations...........................                  88,083                     -

         Total liabilities.............................................               6,507,902            15,305,506
                                                                                   ------------          ------------
Stockholders' equity:
Common stock...........................................................                 606,176               604,948
Additional paid-in capital.............................................             304,789,818           311,308,895
Deferred stock-based compensation......................................              (3,315,046)          (10,081,501)
Stockholder notes receivable...........................................                (652,800)             (652,800)
Accumulated other comprehensive loss...................................                (476,036)             (582,100)
Accumulated deficit....................................................            (238,763,186)         (229,582,352)
                                                                                   ------------          ------------
         Total stockholders' equity....................................              62,188,926            71,015,090
                                                                                   ------------          ------------
                                                                                   $ 68,696,828          $ 86,320,596
                                                                                   ============          ============
</TABLE>



      See accompanying notes to unaudited condensed financial statements.


                                       1
<PAGE>
                                NETPLIANCE, INC.
                       CONDENSED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)



<TABLE>
<CAPTION>
                                                                                               Three Months
                                                                                                  Ended
                                                                                                 March 31,
                                                                                      -----------------------------
                                                                                         2001              2000
                                                                                      -----------      ------------
<S>                                                                                   <C>              <C>
Operating expenses:
     Research and development..........................................               $ 1,972,074      $  1,010,775
     Stock-based compensation..........................................                   225,074         4,485,813
     General and administrative........................................                 2,049,769           882,296
                                                                                      -----------      ------------
         Total operating expenses......................................                 4,246,917         6,378,884
                                                                                      -----------      ------------

         Operating loss................................................                (4,246,917)       (6,378,884)

Interest income, net...................................................                   963,289           612,919
                                                                                      -----------      ------------
     Loss from continuing operations...................................                (3,283,628)       (5,765,965)
     Discontinued operations:
         Loss from operations of a discontinued business...............                (3,697,206)      (35,919,918)
         Loss on disposal of a discontinued business, including
         provision for operating losses during phase-out period........                (2,200,000)                -
                                                                                      -----------      ------------

         Net loss......................................................               $(9,180,834)     $(41,685,883)
                                                                                      ===========      ============

Per share data:
     Net loss..........................................................               $(9,180,834)     $(41,685,883)

     Effect of beneficial conversion feature of convertible preferred
     stock.............................................................                         -       (42,089,262)
                                                                                      -----------      ------------
     Net loss applicable to common stock...............................               $(9,180,834)     $(83,775,145)
                                                                                      ===========      ============

     Net basic and diluted loss from continuing operations
     (net of effect of beneficial conversion feature of
     convertible preferred stock) per common share.....................               $     (0.05)     $      (0.93)

     Net basic and diluted loss from discontinued operations
     per common share..................................................               $     (0.10)     $      (0.70)
                                                                                      -----------      ------------

     Net basic and diluted loss per common share.......................               $     (0.15)     $      (1.63)
                                                                                      ===========      ============

Weighted average common shares outstanding.............................                60,585,561        51,499,370
                                                                                      ===========      ============
</TABLE>



      See accompanying notes to unaudited condensed financial statements.


                                       2
<PAGE>
                                NETPLIANCE, INC.
                       CONDENSED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                                                               Three Months
                                                                                                  Ended
                                                                                                 March 31,
                                                                                   ----------------------------------
                                                                                        2001                 2000
                                                                                   -------------        -------------
<S>                                                                                <C>                  <C>
Cash flows from continuing operating activities:
     Loss from continuing operations...................................             $(3,283,628)        $ (5,765,965)
     Adjustments to reconcile loss from continuing operations to net cash
     provided by/(used in) continuing operating activities:
         Depreciation and amortization.................................                 756,986              322,069
         Accretion of investment securities............................                (711,550)                   -
         Loss on sale of fixed assets..................................                  28,840                    -
         Stock-based compensation expense..............................                 225,074            4,485,813
         Changes in operating assets and liabilities:
              Prepaid expenses.........................................                (437,681)                   -
              Other....................................................                 366,188             (522,380)
              Accounts payable and accrued liabilities.................              (9,111,204)           9,258,207
                                                                                   -------------        -------------
     Net cash provided by/(used in) continuing operating activities....             (12,166,975)           7,777,744
                                                                                   -------------        -------------

Cash flows used in investing activities:
     Purchases of property and equipment...............................                (105,763)            (962,302)
     Purchases of investment securities................................             (25,496,458)         (10,000,000)
     Investment securities sold........................................               4,942,639                    -
     Investment securities matured.....................................              13,126,058                    -
                                                                                   -------------        -------------
     Net cash used in investing activities.............................              (7,533,524)         (10,962,302)
                                                                                   -------------        -------------

Cash flows from financing activities:
     Increase in restricted cash related to capital leases.............                       -           (1,000,000)
     Principal payments on capital lease obligations...................                (261,490)            (223,256)
     Proceeds from issuance of common stock............................                  31,598          133,389,368
     Proceeds from exercise of stock options and warrants..............                   7,197              704,632
     Proceeds from issuance of preferred stock, net....................                       -           58,873,637
     Collection of stockholder notes receivable........................                       -              168,649
                                                                                   -------------        -------------
     Net cash provided by/(used in) financing activities...............                (222,695)         191,913,030
                                                                                   -------------        -------------
Cash provided by/(used in) discontinued operations.....................               2,854,194          (71,808,353)
                                                                                   -------------        -------------

Net decrease/(increase) in cash and cash equivalents...................             (17,069,000)         116,920,119
                                                                                   -------------        -------------

Cash and cash equivalents at beginning of period.......................              27,352,409            9,563,362
                                                                                   -------------        -------------

Cash and cash equivalents at end of period.............................              10,283,409          126,483,481

Short-term investments.................................................              49,016,584           10,000,000
                                                                                   -------------        -------------
Cash, cash equivalents and short-term investments......................             $59,299,993         $136,483,481
                                                                                   =============        =============
</TABLE>




      See accompanying notes to unaudited condensed financial statements.

                                       3
<PAGE>

                         NOTES TO FINANCIAL STATEMENTS

(1)  Incorporation and Nature of Business

     Netpliance, Inc. ("Netpliance" or the "Company") was incorporated in the
State of Texas in January 1999 as Shbang! Inc. In May 1999, the Company's name
was changed to Netpliance, Inc.  On March 15, 2000, the Company was
reincorporated in the State of Delaware.  The Company, after exiting the
consumer Internet appliance and service business in January 2001, operates in
one business segment.

     Currently, the Company is developing a business plan to launch an offering
that will include hardware and software designed to enable broadband service
providers to provide premium services over their telecommunications networks,
which will be initially funded by the Company's existing capital.  As a result
of this shift in business model, the Company expects that it will not generate
any revenue in 2001 from the new business and expects to report significant
operating losses through at least the end of 2001.  There can be no assurance
that the Company will ever achieve positive cash flow from its operations and it
faces numerous risks associated with this proposed transition.

     In January 2001, the Company decided to exit the consumer Internet
appliance and service business due to, among other things, its continued losses
and inability to raise additional capital to fund such business.  The
accompanying financial statements have been restated to present the Company's
consumer Internet appliance and service business as a discontinued operation for
all historical periods presented.  See Note 2, Discontinued Operations.

     To date, the Company has funded its activities primarily through private
equity offerings, which have included sales of its common stock and preferred
stock, and its initial public offering of its common stock on March 17, 2000.
In the future, the Company expects to seek additional funding through private or
public equity offerings, credit facilities or other financing arrangements,
until such time as it achieves positive cash flow from operations. However,
there can be no assurance that such financing will be available or that positive
operating cash flows will be achieved.

     In the opinion of management, the accompanying unaudited condensed
financial statements contain all adjustments, consisting only of normal
recurring adjustments and accruals, necessary for a fair presentation of such
information.  The balance sheet at December 31, 2000, has been derived from the
audited financial statements at that date.  While the Company believes that the
disclosures are adequate to make the information not misleading, it is suggested
that these financial statements be read in conjunction with the audited
financial statements and accompanying notes included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2000.  Interim results are
not necessarily indicative of results expected in future periods.

(2)  Discontinued Operations

     The Company has experienced operating losses since inception as a result
of:  selling its Internet appliance at a significant loss; trying to build and
support its Internet service offering for Internet appliance customers; and
expanding its subscriber base.  In November 2000, the Company shifted its
business model to focus on providing broadband infrastructure and services and
away from its consumer Internet offering.  In connection with this shift in
focus, the Company restructured operations.  The Company reduced headcount by
approximately 38%, primarily in the consumer sales and marketing departments and
in administration.  In January 2001, the Company announced its decision to
discontinue its Internet appliance and service business.  The Company terminated
all marketing and sales efforts related to the consumer Internet appliance and
service business, although the Company continues to provide Internet access to
service customers who had previously purchased an Internet appliance from the

                                       4
<PAGE>

Company.  In February 2001, the Company reduced headcount by an additional 76
employees, and certain members of senior management who were dedicated to the
consumer Internet offering resigned.

     Also in February 2001, the Company entered into an agreement with
EarthLink, Inc. to transfer the Company's service obligations relating to most
of the Company's existing Internet appliance customers.  Pursuant to this
agreement, these Internet appliance customers were offered continued Internet
access only through EarthLink.  Approximately 50,000 of the Company's customers
were transferred to EarthLink's service on March 12, 2001.  The agreement calls
for EarthLink to pay the Company $175 for each customer who transfers to the
EarthLink service and who remains an EarthLink customer through two monthly
billing cycles. After the transfer of the Internet appliance service obligations
to EarthLink, the Company continues to provide Internet access service to 7,000
Internet service customers.  The Company is obligated to provide service to
approximately 6,000 of these customers through November 2001.  After that date,
the Company expects to discontinue providing any Internet access service.

     The Company previously estimated that it would recognize a net gain of
approximately $1.0 million in 2001 in connection with the discontinuance of the
Company's Internet appliance and service business. This estimated gain was based
upon the estimated income from this business until its ultimate disposal in 2001
and the estimated payment by EarthLink for transferred customers. The Company
has since revised the estimate to include the actual loss incurred during the
first quarter of 2001, which totaled approximately $3.7 million, as well as
additional costs of exiting the discontinued Internet appliance and service
business that the Company will incur throughout the remainder of 2001. The
Company now estimates that it will incur a net loss from the discontinuance of
the Internet appliance and service business totaling approximately $5.9 million.

     The primary components included in the Company's revised estimated loss of
approximately $5.9 million, as compared to the initial estimated net gain of
approximately $1.0 million, are related to additional estimated network dialup
costs, additional estimated workforce costs and additional estimated network
operations costs that the Company anticipates incurring during the phase out of
its consumer Internet appliance and service business.

     The revised estimate includes the actual loss incurred during the first
quarter of 2001, but continues to be based upon certain estimates, including the
estimated ultimate payment by EarthLink, the estimated Internet appliance
service revenue and related costs and estimated costs to terminate or
restructure various network service agreements and other contracts and
agreements related to this business.  Any differences between the Company's
estimates and the actual amounts incurred in future periods will change the
estimated net loss accordingly.

Restructuring

     On October 25, 2000, the Company's Board of Directors approved a
restructuring plan designed to reduce the Company's cost structure by
consolidating facilities and reducing the Company's workforce by approximately
38%. As a result, the Company recorded a restructuring charge of approximately
$1.1 million in the fourth quarter of 2000, primarily consisting of costs
associated with closing of facilities and employee severance and benefits. The
following table provides a detail of the charges as well as the amounts accrued
as of March 31, 2001 and December 31, 2000:

<TABLE>
<CAPTION>
                            Accrual at March 31,        Accrual at December 31,             Expensed in
                                    2001                         2000                          2000
                          -----------------------       -----------------------       -----------------------
<S>                       <C>                           <C>                           <C>
Lease termination
costs..................         $  513,450                   $  293,400                    $  293,400
Employee severance.....             12,000                      262,777                       745,236
Other..................                 --                       39,384                        39,384
                          -----------------------       -----------------------       -----------------------
Total..................         $  525,450                   $  595,561                    $1,078,020
                          =======================       =======================       =======================
</TABLE>

                                       5
<PAGE>

     All employees terminated in the restructuring received severance payments
equal to 60 days of salary, plus $1,000 if they executed a release of claims
against the Company.  The reduction in workforce included 93 employees in sales
and marketing, technical support, network operations and the general and
administrative groups.

     The Company recorded approximately $440,000 of additional restructuring
charges during the first quarter of 2001. Also during the first quarter of 2001,
the Company made lease payments totaling approximately $220,000, which was
accrued for as a component of the restructuring charge as of December 31, 2000,
and employee severance payments totaling approximately $250,000 for employees
included in the workforce reduction that occurred during the fourth quarter of
2000.

     In January 2001, the Company's Board of Directors adopted a proposed new
business strategy for the Company, which resulted in additional reductions in
the Company's workforce totaling 76 employees in sales and marketing, technical
support, network operations and the general and administrative groups.  All
employees terminated in the reduction in workforce received severance payments
equal to 60 days of salary, plus $1,000 if they executed a release of claims
against the Company.  As a result, the Company estimates that it will incur
approximately $827,000 of severance costs during 2001.  As of March 31, 2001,
the Company had accrued approximately $207,000 for terminations scheduled to
occur after March 31, 2001.

     As the majority of the Company's restructuring charges recorded in 2000 and
2001 are estimates, the actual amounts paid could differ from those estimates.

     Operating results of the discontinued Internet appliance and service
business are as follows for the quarters ended March 31, 2001 and 2000:

<TABLE>
<CAPTION>
                                                                      Three Months Ended
                                                                          March 31,
                                                            ----------------------------------------
                                                                 2001                       2000
                                                            --------------            --------------
<S>                                                         <C>                       <C>
Subscription revenue.........................                $  2,878,489              $    632,057
Cost of subscription revenue.................                  (4,222,265)               (4,618,559)
Income/(loss) on appliance and other
 peripheral sales............................                      37,354                (7,663,182)
Stock-based compensation.....................                      11,900                (1,704,518)
Sales and marketing..........................                  (1,189,193)              (19,769,451)
General and administrative...................                    (429,909)               (1,445,561)
Research and development.....................                    (343,482)               (1,350,704)
Restructuring charge.........................                    (440,100)                        -
                                                            --------------            --------------
  Loss from discontinued operations..........                $ (3,697,206)             $(35,919,918)
                                                            --------------            --------------
</TABLE>


                                       6
<PAGE>

     Assets and liabilities of the discontinued Internet appliance and service
business are as follows as of March 31, 2001 and December 31, 2000:

<TABLE>
<CAPTION>
                                                     March 31,     December 31,
                                                       2001            2000
                                                   ------------    ------------
<S>                                                <C>             <C>
Current assets...............................      $ 1,277,151      $3,325,917
Property and equipment, net..................        5,451,368       4,967,036
Non-current assets...........................          587,554         390,626
Deferred disposal proceeds...................       (4,716,156)              -

Estimated net loss from disposal including
 losses from operating the discontinued
 business....................................       (2,200,000)              -

Other liabilities............................         (488,000)       (488,000)
                                                   ------------    ------------

Net (liabilities)/assets of discontinued
 operations..................................      $   (88,083)     $8,195,579
                                                   ============    ============
</TABLE>

(3)  Net Loss Per Share

     Basic and diluted net loss per share are presented in conformity with
Statement of Financial Accounting Standard No. 128, "Earnings Per Share."  In
accordance with Statement of Financial Accounting Standard No. 128 and
Securities and Exchange Commission Staff Accounting Bulletin No. 98, basic loss
per share is computed using the weighted average number of common shares
outstanding during the period.  Diluted loss per share is equivalent to basic
loss per share because outstanding stock options and warrants are anti-dilutive.
The calculation of net loss per share excludes potential common shares if their
effect is anti-dilutive.  Potential common shares consist of common shares
issuable upon the exercise of stock options and warrants.

(4)  Capital Stock

Common Stock

     On February 6, 2000, the Board of Directors approved a three-for-one stock
split of common stock and reincorporation of the Company in the State of
Delaware, to be effective immediately prior to the effective date of the
Company's initial public offering.  The reincorporation was completed on March
15, 2000.  All common stock information has been adjusted to reflect the stock
split as if such split had taken place at inception.  On the same date, the
Board of Directors authorized an increase in the number of shares reserved for
issuance under the Company's stock option plan to 10,500,000.

     On March 17, 2000, the Company completed its initial public offering of
8,000,000 shares of common stock and realized net proceeds of approximately
$132.7 million.  As of the closing date of the offering, all outstanding shares
of the Company's convertible preferred stock were converted into shares of
common stock.

Convertible Preferred Stock

     On January 5, 2000, the Company issued 1,430,000 shares of Series D
Convertible Preferred Stock ("Series D"). Net proceeds to the Company
approximated $27.1 million, of which, $2.0 had been received prior to 2000.


                                       7
<PAGE>
     The 1,430,000 shares of Series D and the warrants to purchase 221,400
shares of common stock issued in conjunction with Series D were issued with
beneficial conversion features approximating $27.2 million and $1.4 million,
respectively. The beneficial conversion features were calculated as the
difference between the conversion price and the fair value of the warrants and
common stock into which the preferred stock was convertible. These amounts were
accounted for as an increase in additional paid-in capital and in-substance
dividends to the preferred stockholders on the dates of issuance.

     On February 4, 2000, the Company entered into an irrevocable agreement to
sell 1,127,675 shares of Series E Convertible Preferred Stock ("Series E") for
$30.00 per share in a private placement. The closing for the sale of these
shares was on February 7, 2000.  Net proceeds to the Company approximated $33.8
million.

     The 1,127,675 shares of Series E were issued with a beneficial conversion
feature approximating $13.5 million.  The beneficial conversion feature was
calculated as the difference between the conversion price and the fair value of
the common stock into which the preferred stock was convertible.  This amount
was accounted for as an increase in additional paid-in capital and an in-
substance dividend to the preferred stockholders in the first quarter of 2000,
and accordingly increased the loss applicable to common stockholders by
approximately $13.5 million.  The Series E were convertible at the option of the
holder into shares of common stock at a conversion ratio of one-for-one.

     Each share of Series D and E converted into three shares of common stock
upon the Company's consummation of its public offering of its common stock, or
4,290,000 and 3,383,025 shares, respectively, totaling 7,673,025 shares of
common stock as a result of the conversion provision of such stock and the stock
split effectuated with the Company's initial public offering.

(5)  Stock Options

Stock Option Plan

     In January 2001, the Company granted to non-employee directors options to
purchase an aggregate of 210,000 shares of common stock at an exercise price of
$0.53 per share, which were fully vested at the time of the grant.  In the three
months ended March 31, 2001, the Company granted to employees options to
purchase an aggregate of 5,815,576 shares of common stock at exercise prices
ranging from $0.31 to $0.56 per share, which will vest over a period of three or
four years.  Certain of these options also have a one year change of control
acceleration clause.  Included in these employee options were options to
purchase 5,410,576 shares of common stock granted to continuing and new
employees at exercise prices ranging from $0.31 to $0.44 per share, which were
granted subject to availability of shares of unreserved common stock in the
option plan pool.

     The Company has recorded approximately $225,000 of compensation expense in
the first quarter of 2001 as a result of granting stock options in 1999 and 2000
with exercise prices below the estimated fair value of the stock at the date of
grant.  Also, during the first quarter of 2001, the Company eliminated
approximately $6.5 million of unrecognized deferred stock compensation as a
result of employee terminations and voluntary departures.  Remaining deferred
compensation of approximately $3.3 million will be amortized over the applicable
vesting period. The Company may have to record additional deferred stock-based
compensation in the future as shares of common stock become available for the
options granted in the first quarter of 2001 subject to such availability, if
the fair market value of the Company's common stock on the date those shares
become available is greater than the exercise price of the options.

(6)  Commitments and Contingencies

     The Company is involved in certain legal proceedings as a part of its
normal course of business.

     In 2000, the Federal Trade Commission initiated an investigation of certain
of the Company's practices in marketing its Internet appliances and related
services, including whether the Company was in compliance with the FTC's Trade
Regulation Rule Concerning the Sale of Mail or Telephone

                                       8
<PAGE>

Merchandise. As a result of the investigation and discussions between the
Company and the FTC, the Company and the FTC staff conducting the investigation
entered into a tentative settlement. The settlement is in the form of a Consent
Decree and Order for Injunctive Relief, Consumer Redress, Civil Penalties, and
Other Relief. If the draft Complaint and Consent Decree are approved by the FTC
and the court in which the Complaint and Consent Decree will be filed, the
Company, without admitting liability for any of the matters alleged in the
Complaint, will be required, among other things, to pay a civil penalty of
$100,000 for the alleged violations.

     On March 1, 2001, Spyglass, Inc. filed a lawsuit against the Company
seeking in excess of $300,000 in damages for the alleged breach of a contract
relating to software development by Spyglass for the Company's discontinued
business. The Company has filed a denial and counterclaim against Spyglass for
breach of contract. The case is pending in state court in DuPage County,
Illinois.

     The Company has commenced litigation in Austin, Texas, against Data
Exchange Corporation ("DEX") for actions arising from DEX's refusal to release
to the Company the remaining inventory of the Company's Internet appliances held
by DEX. The lawsuit asserts causes of action for breach of contract and
conversion. DEX has answered the suit and denied the Company's claims. The
action is currently pending in the United States District Court for the Western
District of Texas, Austin Division.

     During the first quarter of 2001, the Company entered into an agreement
with AT&T Corp. that released the Company from its obligations to purchase
Internet dialup services under a contract entered into in July 2000.  The terms
of this agreement call for the Company to pay a $250,000 termination penalty,
and commit the Company to purchasing an additional $750,000 of products and/or
services from AT&T Corp. before March 1, 2002.

     The Company has continuing material commitments under several contracts
related to it discontinued business, including a $2.4 million commitment under a
facility lease expiring in 2005.  In July 2000, the Company entered into a
network services agreement with Genuity Solutions, Inc. to provide dialup
Internet service to the Company's customers.  Under this agreement, the Company
is obligated to pay minimum commitment amounts over the three-year term of the
agreement equaling $200,000 per month.  The Company may terminate this network
services agreement for any reason upon 60 days prior written notice upon the
payment of a termination fee.  The termination fee for this network services
agreement is based upon a percentage of the commitment level at the time of
termination and the remaining term of the agreement.

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

     This report, including the discussion in Management's Discussion and
Analysis of Results of Operations and Financial Condition, contains trend
analysis and other forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended.  All statements other than statements of
historical fact are "forward-looking statements" for purposes of federal and
state securities laws, including:  any projections of earnings, revenues or
other financial items; any statements of the plans, strategies and objectives of
management for future operations; any statements concerning proposed new
products, services or developments; any statements regarding future economic
conditions or performance; any statements of belief; and any statements of
assumptions underlying any of the foregoing.  Forward-looking statements may
include the words "may," "will," "estimate," "intend," "continue," "believe,"
"expect" or "anticipate" and other similar words.

     Although we believe that the expectations reflected in any of our forward-
looking statements are reasonable, actual results could differ materially from
those projected or assumed in any of our forward-

                                       9
<PAGE>

looking statements. Our future financial condition and results of operations, as
well as any forward-looking statements, are subject to change and to inherent
risks and uncertainties, such as those disclosed in this report. We do not
intend, and undertake no obligation, to update any forward-looking statement.

     Actual results could differ materially from those set forth in such
forward-looking statements as a result of the "Factors That May Affect Future
Operating Results" and other risks detailed in this report and our other reports
filed with the Securities and Exchange Commission.  We urge you to review
carefully the section "Factors Affecting Operating Results" in this report for a
more complete discussion of the risks associated with an investment in our
securities.

Overview

     Since our organization in 1999, we have primarily offered consumers
Internet access through devices commonly known as Internet appliances, which we
also marketed and sold to our customers. Recently, however, we have changed our
strategic focus and are exiting this consumer business. We are now developing a
business plan to launch a hardware and software offering designed to enable
broadband service providers to provide premium services over their
telecommunications networks.

     In November 2000, we began shifting our business model to focus on
providing broadband infrastructure and services and away from our consumer
Internet offering. In connection with this shift in focus, we restructured our
operations. We reduced our headcount by approximately 38%, primarily in our
consumer sales and marketing departments and in administration. In January 2001,
we terminated all marketing and sales efforts related to our consumer Internet
appliances, although we continued to service customers who had previously
purchased our Internet appliances. In February 2001, we reduced our headcount by
an additional 76 employees, and certain members of senior management who were
dedicated to our consumer Internet offering resigned.

     Also in February 2001, we entered into an agreement with EarthLink, Inc.
for the transfer of our service obligations relating to most of our existing
Internet appliance customers. Pursuant to this agreement, these customers were
offered continued Internet access only through EarthLink. Approximately 50,000
of our customers were transferred to EarthLink's service on March 12, 2001. The
agreement calls for us to receive payments from EarthLink at a rate of $175 for
each of our customers who transferred to the EarthLink service and who remains
an EarthLink customer through two monthly billing cycles.

     After the transfer of our service obligations to EarthLink, we continue to
provide Internet access service to approximately 7,000 customers. We have the
obligation to provide service to approximately 6,000 of these customers through
November 2001. After that date, we expect to discontinue providing any Internet
access service. We have terminated our obligations under one network services
agreement and anticipate terminating or restructuring others, which could result
in significant termination fees or other charges. We also have continuing
warranty obligations, through January 2002, relating to the Internet appliances
we sold to our customers. We are continuing to operate our Internet portal, but
we expect the EarthLink customers to be transitioned to an EarthLink portal in
the future. In general, we are in the process of exiting our consumer-focused
business entirely, but will continue to have significant obligations and
potential liabilities relating to this business.

     As a result of our change in business strategy, the results of operations
for all prior periods presented have been restated for the effect of
discontinued operations related to the Internet appliance and service business.

                                       10
<PAGE>

Results of Continuing Operations

Revenues

     We are still in the planning stages of our initiative.  We are currently
developing a prototype to test the feasibility of our new business plan.  We are
also developing new software for our planned products.  We have no sales
contracts with potential customers for our suite of potential products and
services.  We had no revenue from continuing operations for the quarters ended
March 31, 2001 or 2000.

Expenses

     Research and development expenses.  Our research and development expenses
from continuing operations consist primarily of salaries of employees in this
area who remained with us to assist in developing our broadband initiative, and
other expenses relating to the development of that initiative.  Research and
development expenses from continuing operations totaled approximately $2.0
million and $1.0 million for the quarters ended March 31, 2001 and 2000,
respectively.  Our research and development expenses increased in 2001 due
primarily to an increase in employment costs and depreciation expense on
development equipment.

     Stock-based compensation.  Our stock-based compensation for continuing
operations totaled approximately $225,000 for the quarter ended March 31, 2001,
as compared to approximately $4.5 million for the quarter ended March 31, 2000.
These expenses are attributable primarily to stock options granted prior to and
during the first quarter of 2000 with exercise prices that were less than the
estimated fair value of the underlying common stock on the date of grant.
Additional deferred stock-based compensation totaled approximately $3.3 million
as of March 31, 2001.  This amount will be amortized over the remaining vesting
period of the options that were outstanding as of March 31, 2001.

     General and administrative expenses.  General and administrative expenses
consist primarily of employee salaries and related expenses for the executive,
administrative, finance and information systems departments, and facility costs,
professional fees and recruiting.  Our general and administrative expenses from
continuing operations were approximately $2.0 million and $900,000 for the
quarters ended March 31, 2001 and 2000, respectively.  The increase in these
expenses was primarily a result of an increased number of employees, an increase
in corporate facility costs and an increase in depreciation expense on corporate
assets.

     Interest income.  Our interest income, net of interest expense, totaled
approximately $1.0 million for the quarter ended March 31, 2001, as compared to
approximately $600,000 for the quarter ended March 31, 2000.  The increase in
interest income is due to a general increase in the average cash balances we
held at banking and financial institutions throughout the entire first quarter
of 2001.

Discontinued Operations

     We have experienced operating losses since inception as a result of selling
our Internet appliance at a significant loss, trying to build and support our
Internet service offering for our Internet appliance customers and trying to
expand our customer base.  In November 2000, we shifted our business model to
focus on providing broadband infrastructure and services and away from our
consumer Internet offering.  In connection with this shift in focus, we
restructured our operations.  We reduced our headcount by approximately 38%,
primarily in the consumer sales and marketing departments and in administration.
In January 2001, we announced our decision to discontinue our Internet appliance
and service business.  At that time, we terminated all marketing and sales
efforts related to the consumer Internet appliance and service business,
although we continued to service customers who had previously purchased an
Internet appliance from us.  In February 2001, we reduced our headcount by an
additional 76 employees, and certain members of senior management who were
dedicated to the consumer Internet offering resigned.

                                       11
<PAGE>

     Also in February 2001, we entered into an agreement with EarthLink, Inc. to
transfer our service obligations relating to approximately 50,000 of our
Internet appliance customers. Those customers were transferred to EarthLink on
March 12, 2001. The agreement requires EarthLink to pay us $175 for each of our
customers who transfers to the EarthLink service and who remains an EarthLink
customer through two billing cycles. After the transfer of our service
obligations to EarthLink, we continue to provide Internet access service to
approximately 7,000 Internet service customers. We are obligated to provide
service to approximately 6,000 of these customers through November 2001. After
that date, we expect to discontinue providing any Internet access service.

     We previously estimated that we would recognize a net gain of approximately
$1.0 million in 2001 in connection with the discontinuance of our Internet
appliance and service business. This estimated gain was based upon the estimated
income from this business until its ultimate disposal in 2001 and the estimated
payment by EarthLink for transferred customers. We have since revised the
estimate to include the actual loss incurred during the first quarter of 2001,
as well as additional costs of exiting the discontinued Internet appliance and
service business that we will incur throughout the remainder of 2001. We now
estimate that we will incur a net loss from the discontinuance of the Internet
appliance and service business totaling approximately $5.9 million. The revised
estimate includes the actual loss incurred during the first quarter of 2001, but
continues to be based upon certain estimates, including the estimated ultimate
payment by EarthLink, the estimated Internet appliance service revenue and
related costs and estimated costs to terminate or restructure various network
service agreements and other contracts and agreements related to this business.
Any differences between our estimates and the actual amounts incurred in future
periods will change the estimated net loss accordingly.

     Net loss from our discontinued Internet appliance and service business
totaled approximately $3.7 million and $35.9 million for the quarters ended
March 31, 2001 and 2000, respectively.  The net loss from discontinued
operations for the quarter ended March 31, 2001 includes approximately $2.9
million of revenues from the Internet appliance service business, sales and
marketing costs of approximately $1.2 million, and network operation costs of
approximately $4.2 million.  In addition, we recorded an additional
restructuring charge of approximately $440,000 consisting of costs associated
with the closing of some of our facilities and approximately $827,000 of
severance costs relating to our reduction in workforce in February 2001.  In
comparison, the net loss from discontinued operations for the quarter ended
March 31, 2000 includes approximately $600,000 of revenues from the Internet
appliance service business, sales and marketing costs of approximately $19.8
million, network operation cost of approximately $4.6 million and loss on
subsidized appliance and peripheral sales of approximately $7.7 million.

     The increase in Internet appliance services revenues is attributable to an
increase in the number of subscribers to approximately 55,000 during the first
quarter of 2001, as compared to approximately 20,000 as of March 31, 2000.  The
decrease in the loss on subsidized appliance and peripheral sales is due to our
discontinuance of all Internet appliance and peripheral sales in January 2001.
The decrease in sales and marketing costs is due to a general reduction in sales
and marketing personnel and a complete suspension of all marketing and media
campaigns during the first quarter of 2001.

     We have continuing material commitments under several contracts related to
this discontinued business, including a $2.4 million commitment under a facility
lease expiring in 2005.  In July 2000, we entered into a network services
agreement with Genuity Solutions, Inc. to provide dial-up Internet service to
our customers.  Under this agreement, we are obligated to pay minimum commitment
amounts over the three-year term of the agreement equaling $200,000 per month.
We may terminate this network services agreement for any reason upon 60 days
prior written notice upon the payment of a termination fee.  The termination fee
for this network services agreement is based upon a percentage of the commitment
level at the time of termination and the remaining term of the agreement.

     During the first quarter of 2001, we entered into an agreement with AT&T
Corp. that released us from our obligations to purchase Internet dialup services
under a contract entered into in July 2000.  The

                                       12
<PAGE>

terms of this agreement call for us to pay a $250,000 termination penalty, and
commit us to purchasing an additional $750,000 of products and/or services from
AT&T Corp. before March 1, 2002.

Liquidity and Capital Resources

     From inception in January 1999 through March 31, 2001, we financed our
operations and met our capital expenditure requirements primarily from the net
proceeds of the private and public sale of equity securities totaling
approximately $230.0 million.  As of March 31, 2001, we had approximately $59.3
million in cash, cash equivalents and short-term investments, compared to
approximately $136.5 million as of March 31, 2000.  Although we have taken steps
to decrease our future operating expenses, our new strategic focus will require
significant capital to fund operating losses, research and development expenses,
capital expenditures and working capital needs until such time as we achieve
positive cash flows from operations.  We estimate that we have adequate cash to
meet our needs for the next 12 months.  We cannot give any assurance that any
additional financing will be available, that we can ever achieve positive
operating cash flows or that we will have sufficient cash from any source to
meet our needs.  It is possible that we will exhaust all available funds before
we reach the positive cash flow phase of our proposed business model.

     Working capital decreased by approximately $69.4 million, to $53.8 million
as of March 31, 2001 from $123.2 million as of March 31, 2000.  The decrease in
working capital is primarily the result of losses incurred in both our
continuing and discontinued operations during the final three quarters of 2000
and the first quarter of 2001.

     Net cash used in continuing operating activities was approximately $12.2
million for the quarter ended March 31, 2001, compared to net cash provided of
approximately $7.8 million for the quarter ended March 31, 2000.  The decrease
in cash provided by operating activities is primarily the result of a reduction
of accounts payable and accrued liabilities of approximately $9.1 million during
the first quarter of 2001.

     Net cash used in investing activities was approximately $7.5 million and
$11.0 million for the quarters ended March 31, 2001 and 2000, respectively.
Cash used in investing activities consists of the purchase of property and
equipment and the purchase, sale and maturity of certain investment securities.

     Net cash used in financing activities was approximately $200,000 for the
quarter ended March 31, 2001, compared to net cash provided by financing
activities of approximately $191.9 million for the quarter ended March 31, 2000.
The $191.9 million provided during the quarter ended March 31, 2000 includes
approximately $133.4 million of net proceeds from the sale of 8,000,000 shares
of our common stock in our initial public offering and approximately $58.9
million of net proceeds from the private sale of shares of our preferred stock.

     Net cash provided by discontinued operations was approximately $2.9 million
for the first quarter of 2001, as compared to net cash used in discontinued
operations of approximately $71.8 million for the first quarter of 2000.  The
increase in cash provided by discontinued operations during the first quarter of
2001 is primarily due to the receipt of approximately $4.7 million from
EarthLink as partial payment under the agreement for the transfer of our service
obligations relating to most of our Internet appliance customers, and the
discontinuance of our Internet appliance and peripheral sales in January 2001.


                                       13
<PAGE>

Factors Affecting Operating Results

     There are numerous risks affecting our proposed business and our
discontinued operations, some of which are beyond our control. These risks
relate to our efforts in transitioning to our new strategic focus, the launch of
our new broadband initiative and the discontinuation of our old line of
business. An investment in our common stock involves a high degree of risk and
may not be appropriate for investors who cannot afford to lose their entire
investment. In addition to the risks outlined below, risks and uncertainties not
presently known to us or that we currently consider immaterial may also impair
our business operations. Our future operating results and financial condition
are heavily dependent on our ability to successfully develop, manufacture and
market technologically innovative broadband solutions in order to meet customer
demand patterns in the telecommunications industry. Inherent in this process are
a number of factors that we must successfully manage if we are to achieve
positive future operating results in the future. Potential risks and
uncertainties that could affect our operating results and financial condition
include, without limitation, the following:

     We cannot predict our future results because we have a limited operating
     history and have recently changed our strategic focus.

     We have a limited operating history and no history operating our proposed
broadband solutions line of business. We were incorporated in January 1999 and
we began offering our Internet appliance and service in November 1999. We began
exploring our proposed broadband initiative in November 2000. Our proposed
broadband solutions are in the planning and early stage and are a new strategic
focus for us. There are significant risks and costs inherent in our efforts to
undertake our proposed broadband initiative and to transition to a new business
model. These include the risk that we may not be able to develop a viable
broadband product, achieve market acceptance for our proposed line of products
and services or earn revenues from the sale of such products and services, that
our proposed operations, if started at all, may not be profitable and other
significant risks related to the changes in our business model described below.
Our prospects must be considered in light of the uncertainties and difficulties
frequently encountered by companies in their early stages of development. These
risks are heightened in new and rapidly evolving industries, such as broadband,
specifically, and telecommunications, generally. It is possible that we will
exhaust all available funds before we reach the positive cash flow phase of our
proposed business model.

     We may have difficulty in raising capital and making an effective
     transition because of our history.

     Our first attempt at achieving profitability, by developing and marketing
our Internet appliance and related services, was unsuccessful. Therefore, it may
be more difficult for us to make an effective transition into an infrastructure
technology company in the telecommunications market, especially in the areas of
raising capital, attracting and retaining talented employees, attracting
research analyst coverage of our common stock and gaining the confidence of
possible strategic relationships, substantial investors and new customers for
our proposed new business.

     The transition to our proposed business model is risky and expensive.
     We expect to incur operating losses throughout at least the remainder of
     2001, and it is possible that we may never become profitable.

     As part of our restructuring effort begun in late 2000, we changed our
strategic focus. Successful implementation of our reorganization continues to
involve several risks. These risks include:

          .    reliance upon unproven products and technology;

                                       14
<PAGE>

          .    our unproven and evolving business model;

          .    market acceptance of any new products and services we are able to
               develop;

          .    our ability to anticipate and adapt to a developing market and to
               rapidly changing technologies;

          .    the effect of competitive pressures in the marketplace;

          .    our need to structure our internal resources to support the
               development, marketing, and future growth of our potential
               products and service offerings;

          .    uncertainties concerning our strategic direction and financial
               condition;

          .    our need for broadband service providers to launch and maintain
               services that create a need for the new products and services we
               intend to develop;

          ,    the uncertainty of market acceptance of broadband services
               utilizing our proposed line of products and services;

          ,    our need to introduce reliable products and services that meet
               the demanding needs of broadband service providers; and

          .    our need to realign and enhance our business development,
               research and development, product development, consulting and
               support organizations, and expand our distribution channels, to
               develop our proposed business plan.

     Even if our new business model is successfully implemented, there can be no
assurance that it will effectively resolve the various issues we currently face
in our transition. In addition, although we believe that the actions that we are
taking under our reorganization plan will help us become profitable, there can
be no assurance that such actions will succeed in the long or short term.

     Internal and external changes resulting from our reorganization and
transition towards our new strategic focus may concern our potential customers,
strategic relationships, distributors and employees, and create a prolonged
period of uncertainty, which could have a material adverse affect on our
business.  Our new strategy requires substantial changes, including pursuing new
strategic relationships, increasing our research and development expenditures,
adding employees who possess the skills we believe we will need going forward,
investing in new technologies, establishing leadership positions in new high-
growth markets and realigning and enhancing our sales and marketing departments.
Many factors may impact our ability to implement this strategy, including our
ability to finalize agreements with other companies, manage the implementation
internally, sustain the productivity of our workforce, introduce innovative new
products in a timely manner, manage operating expenses and quickly respond to,
and recover from, unforeseen events associated with our transition and
realignment.

     As a result of our reorganization, it is extremely difficult to forecast
our future financial performance. We are now in the initial stages of pursuing a
new business plan. Therefore, we have not achieved profitability and expect to
continue to incur net losses at least through 2001. We expect to incur
significant research and development, product development, administrative and
operating expenses in the future. Only if we are able to successfully develop
our proposed products, bring them to market before our competitors and our
target market accepts our solutions will we be able to generate any significant
revenues from our proposed business model. It is possible that we will exhaust
all available funds before we reach the positive cash flow phase of our proposed
business model.

                                       15
<PAGE>

     We will not be able to develop or continue our business if we fail to
     attract and retain key personnel.

     Our future success depends on our ability to attract, hire, train and
retain a number of highly skilled employees and on the service and performance
of our senior management and other key personnel.  The loss of the services of
our executive officers or other key employees could adversely affect our
business.  Recently, a significant number of our employees have been terminated
in cost-cutting and restructuring activities or voluntarily departed to pursue
other opportunities.  Our facilities are located in Austin, Texas, which has a
high demand for technical and other personnel and a relatively low unemployment
rate.  Competition for qualified personnel possessing the skills necessary for
success in the competitive market of broadband and telecommunications related
services is intense, and we may fail to attract or retain the employees
necessary to execute our new business model successfully.

     Our potential customers' use of our planned line of products will require
implementation services. Although we plan to provide implementation services
sufficient to meet our expected business level, our growth will be limited in
the event we are unable to hire or retain implementation services personnel or
subcontract these services to qualified third parties.

     We have recently lost key personnel who we will need to replace. Moreover,
we will need to hire a number of additional research and development, business
development, support and marketing employees in 2001 and beyond to develop and
grow our proposed business. If we fail to attract qualified personnel or retain
current employees we need, including our executive officers and other key
employees, we may not be able to generate revenues. Our relationships with these
officers and key employees are "at will." Moreover, we do not have "key person"
life insurance policies covering any of our employees.

     Some members of our management team have joined us only recently.  Our
success depends to a significant degree upon the continued contributions of our
key management, engineering, research and development, business development and
marketing and other personnel, many of whom would be difficult to replace.  In
particular, we believe that our future success is highly dependent on John F.
McHale, our chairman and chief executive officer.

     The market potential for our proposed product lines is unproven, and may
     not develop as we hope, which could result in our failure to achieve sales
     and profits from our proposed business model.

     Our proposed business model involves an emerging market. Therefore, our
financial performance and any future growth will depend upon the rapid growth of
new markets for the broadband products and services we hope to develop, and our
ability to establish a leadership position in those markets. We intend to invest
a significant proportion of our resources in the emerging broadband markets that
we anticipate will grow at a significantly higher rate than the networking
industry on average. At the present time, the markets for broadband solutions
are in their infancy, and we are not certain that our target customers will
widely adopt and deploy our technology. Even if are able to develop solutions
that are effective, our target customers may not choose to use them for
technical, cost, support or other reasons. Industry standards for these
technologies are yet to be widely adopted and the market potential remains
unproven. If the markets for broadband solutions do not develop as we hope, and
our potential products and services do not meet the demand in these markets, we
may never achieve revenues and profits from the sale of our anticipated
broadband solutions. We cannot be certain that a broad-based market for our
products or services will ever emerge or be sustainable if it does emerge. We
also cannot be certain that, if the market develops, new technology may replace
broadband. If this market does not develop, develops more slowly than we expect
or does not retain acceptance, our business, results of operations and financial
condition will be seriously harmed.

                                       16
<PAGE>

     If we are unable to develop our proposed line of products and services, our
     proposed business will suffer.

     We hope to develop and then deliver to market an integrated hardware,
software and service solution based on technology that will allow broadband
service providers to rapidly create premium services.  If we are unsuccessful in
developing this new technology, we will have no products or services to bring to
market and, therefore, will never be able to generate revenues from our proposed
line of products and services, and our business will suffer.  Also, if we
exhaust all available funds before we can develop our proposed line of products
and services, we will not have a product or complimenting services to bring to
market, and our proposed business will suffer.

     If we are unable to develop and introduce new products and services
     quickly, our proposed business will suffer.

     Products and services in the markets in which we intend to compete have
short life cycles. Therefore, our success will depend upon our ability to
identify new market and product opportunities, to develop and introduce new
products and services in a timely manner and to gain market acceptance of any
new products and services developed, particularly in our targeted high-growth,
emerging markets.

     Any delay in new product and service introductions or lower than
anticipated demand for the new products and services we hope to develop could
have an adverse affect on our operating results or financial condition.

     If we are unable to integrate our products with third-party technology, our
     proposed business may suffer.

     If developed, our proposed line of broadband products and services must be
able to be integrated with the third party network and routing devices used by
our potential customers. If our products are unable to integrate with these
third-party technologies, our business would suffer materially. For example, if,
as a result of technology enhancements or upgrades of these systems, we are
unable to integrate our products with these systems, we could be required to
redesign our products or they would be considered obsolete by our potential
customers. Moreover, many broadband service providers use custom-made systems
for their general network management software. Custom-made systems are typically
very difficult to integrate with new infrastructure products, such as the
products we hope to develop for this market.

     Marketing to most of our potential customers is difficult because they are
     large organizations.

     We will market our potential line of products and services primarily to
large organizations. The adoption and integration of products and services by
large organizations is complex, time consuming and expensive. In many cases, our
potential customers must consider a wide range of issues before committing to
use our proposed line of products and services, including benefits, ease of use,
ability to work with existing systems, functionality and reliability.
Furthermore, we must educate our potential customers on the use and benefits of
our products and services. In addition, we believe that the purchase of our
proposed line of products and services often will be discretionary. It will
frequently take several months to develop any potential customer relationship
and will require approval at a number of management levels within the potential
customer's organization. These long cycles may cause delays in any potential
sale and we may spend a large amount of time and resources on potential
customers who decide not to use our proposed line of products and services,
which could materially and adversely affect our business.

                                       17
<PAGE>

     Our proposed business will suffer if our target customers do not accept our
     broadband technology enhancement solutions.

     If we can develop our proposed product line, our future revenues and
profits, if any, will depend upon the widespread acceptance and use of broadband
enhancement technology by our target market, and use of broadband technology as
an effective medium of commerce and communication by the customers of broadband
service providers. Growth in the use of and interest in broadband access has
occurred only recently. As a result, acceptance and use may not continue to
develop at historical rates, and a sufficiently broad base of consumers may not
adopt, and continue to use, broadband services as a medium of commerce and
communication. Our success will depend, in large part, on the acceptance of
broadband technology in the commercial marketplace and on the ability of
broadband service providers to provide reliable access and services. To the
extent that broadband technology continues to experience increased numbers of
users, increased frequency of use or increased bandwidth requirements of users,
service providers may not be able to support the demands placed on them and the
performance or reliability of their service could suffer.

     Substantially all of our anticipated revenues, if any, may come from sales
of one or two product and service lines, making us dependent on widespread
market acceptance of these products and services. We may be more dependent on
the market acceptance of individual product and service lines than our
competitors with broader offerings. Factors that may affect the market
acceptance of our anticipated line of products and services include:

          .    adoption of advanced routing and switching products and
               technologies;

          .    the performance, price and total cost of ownership of our planned
               line of products and services;

          .    the availability and price of competing products and
               technologies; and

          .    the success and development of our business development and
               marketing organizations.

     If our products do not comply with complex governmental regulations
     and evolving industry standards, our products may not be widely accepted,
     which may prevent us from earning revenues or achieving profitability.

     The market for broadband solutions is characterized by the need to support
industry standards as different standards emerge, evolve and achieve acceptance.
To be competitive, we will need to develop and introduce new products and
product enhancements that meet these emerging standards. We may have to delay
the introduction of new products to comply with third party standards testing.
We may be unable to address compatibility issues that arise from technological
changes and evolving industry standards.

     Our proposed products will have to comply with various governmental
regulations and industry regulations and standards, including those defined by
the Federal Communications Commission, Underwriters Laboratories and Networking
Equipment Building Standards. If we do not comply with existing or evolving
industry standards or fail to obtain timely regulatory approvals or
certificates, we will be unable to sell any products that we are able to develop
where these standards or regulations apply, which may prevent us from generating
revenues or achieving profitability.

     Competition in the broadband solutions market may reduce the demand for, or
     price of, our intended products and services.

     The telecommunications market is intensely competitive and rapidly
changing. We expect that competition in this market will intensify in the near-
term because of the attention broadband is currently

                                       18
<PAGE>

receiving and because there are very limited barriers to entry. Our primary
long-term competitors may not have entered the market yet because the broadband
market is new. Competition could result in price reductions, fewer customer
orders, reduced gross margin and loss of market share, any of which could cause
our business to suffer. We may not be able to compete successfully, and
competitive pressures may harm our business. Many of our potential competitors
have greater name recognition, longer operating histories, larger customer bases
and significantly greater financial, technical, marketing, public relations,
sales, distribution and other resources than we do. Some of our potential
competitors are among the largest and most well-capitalized technology companies
in the world.

     We are likely to experience delays in revenue recognition and be required
     to encumber available funds in order to secure certain business
     relationships, which may cause our proposed business to suffer.

     We believe that, due in part to the recent turbulence in the financial
markets and market skepticism about the stability of technology companies like
ours, some companies have begun to, and may in the future, require companies
such as us to post bonds, obtain letters of credit or otherwise encumber
available funds as a pre-requisite for entering into business relationships with
as suppliers, vendors, co-marketers, tenants and other types of conventional
business relationships.  If we are required to encumber our resources in order
to establish or maintain our current or future business relationships, our cost
to establish and maintain such relationships will increase and the profitability
we may achieve, if any, will be reduced or delayed as a result, or we may not
enter into some relationships that would otherwise benefit the development of
our proposed business due to such requirements.

     If we are unable to acquire key components or are unable to acquire them on
     favorable terms, our proposed business will suffer.

     Some key components of our proposed line of products and services on which
we will rely are currently available only from single or limited sources and are
in the development stage. In addition, some of these suppliers will also be our
competitors. We cannot be certain that we will be able to meet our demand for
components in a timely and cost-effective manner. For example, due to strong
world-wide demand, the electronics industry is facing shortages on various
memory devices and passive components. Due to these shortages, our ability to
procure these components and meet potential delivery requirements in a cost-
effective manner could be impacted. Our operating results, financial condition,
or relationships with potential customers could be adversely affected by these
shortages. These adverse effects could result from an inability to fulfill
customer demand or increased costs to acquire key components or services.

     We may not be able to compete effectively if we are not able to protect our
     intellectual property.

     We intend to rely on a combination of trademark, trade secret and copyright
law and contractual restrictions to protect the intellectual property we
develop. We have applied to register several trademarks relating to our
discontinued operations in the United States. We have not yet attempted to
register other marks that may become important to us in the future. We have
several United States patent applications relating to our discontinued
operations currently pending. We anticipate filing additional patent
applications relating to our proposed broadband solutions business. If we are
not successful in obtaining the patent protection we need, our competitors may
be able to replicate our technology and compete more effectively against us. The
legal protections described above would afford only limited protection.
Unauthorized parties may attempt to copy aspects of our products and services,
or otherwise attempt to obtain and use our intellectual property. Enforcement of
trademark rights against unauthorized use, particularly in the technology sector
and in other countries, may be impractical or impossible and could generate
confusion and diminish the value of those rights.

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<PAGE>

     Litigation may be necessary to enforce our intellectual property rights, to
protect our trade secrets and to determine the validity and scope of the
proprietary rights of others. Any litigation could result in substantial costs
and diversion of our resources and could seriously harm our business and
operating results. In addition, our inability to protect our intellectual
property may harm our business and financial prospects.

     Our continued Nasdaq National Market listing is not assured.

     Our common stock is presently authorized for quotation on the Nasdaq
National Market. Accordingly, we are subject to all requirements of our listing
agreement with Nasdaq. Among the events that could cause us to have our status
as a National Market Issuer terminated are:

          .    failure to maintain a minimum bid price for the common stock of
               either $1.00 per share or $5.00 per share, depending on, among
               other things, whether or not our tangible net assets are greater
               than or less than $4 million;

          .    failure to maintain an audit committee that comports to the
               independence and other standards of the Nasdaq and the SEC; and

          .    failure to timely hold annual meetings of stockholders and comply
               with other corporate governance requirements.

     On November 13, 2000 our stock price first closed below $1.00. From the
period of December 1, 2000 through May 9, 2001 our stock price has closed below
$1.00 at the end of each trading day, and on the last trading day of this period
our stock price closed at $0.37. On April 18, 2001, we received notice from
Nasdaq that our stock price had failed to maintain the minimum bid price of at
least $1.00 for 30 consecutive trading days, that we had exhausted the
applicable grace period and that our common stock would be delisted on April 26,
2001 unless we appealed such determination and Nasdaq granted us a waiver of
such requirement. On April 19, 2001, we notified Nasdaq that we would appeal
such determination, which automatically stayed the scheduled delisting of our
common stock. We will seek such a waiver and secure continued listing on the
Nasdaq National Market at a hearing scheduled for June 7, 2001 with Nasdaq.
However, we can give no assurances that we will be granted such a waiver. If we
lose our Nasdaq National Market status, we anticipate that our common stock
would trade in the over-the-counter market, which is viewed by most investors as
a less desirable, and less liquid, marketplace.

     Our officers, directors and affiliated entities own a large percentage of
     our outstanding stock and could significantly influence the outcome of
     actions.

     Our executive officers, directors and entities affiliated with them, in the
aggregate, own approximately 57% of our outstanding stock as of April 30, 2001.
These stockholders, if acting together, would be able to determine all matters
requiring approval by our stockholders, including the election of directors and
the approval of mergers or other business combination transactions.

     Our chairman and chief executive officer, John F. McHale, entered into
management buyout agreements with each of Kent A. Savage, Kenneth A. Kalinoski,
David S. Lundeen and Watershed Capital I L.P. Together, this group beneficially
owns approximately 52% of our outstanding stock as of April 30, 2001, and
pursuant to these agreements Mr. McHale could initiate or block significant
matters affecting us. In January 2001, this group terminated discussions with
our board of directors relating to a possible management buyout. However, given
that the management buyout agreements are still in effect, it is possible that
this group or a portion thereof may initiate discussions for a going private
transaction with respect to us in the future.

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<PAGE>

     The large number of shares eligible for public sale could cause our stock
     price to decline.

     The market price of our common stock could further decline as a result of
sales by our existing stockholders of a large number of shares of our common
stock in the market, or the perception that such sales could occur. This
[Arcumstance could become a more significant issue at such time as shares sold
in past or future private placements are either registered or may be resold in
reliance on Rule 144 of the Securities Act of 1933.

     We may be unable to obtain the additional capital required to grow our
     business, which could seriously harm our proposed business. If we raise
     additional funds, our current stockholders may suffer substantial dilution.

     As of March 31, 2001, we had approximately $59.3 million in cash, cash
equivalents and short-term investments on hand, which we expect will meet our
working capital and capital expenditure needs for at least the next 12 months.
We may need to raise additional funds at any time, and given our history, we
cannot be certain that we will be able to obtain additional financing on
favorable terms, if at all.  Due to the recent volatility of the U.S. equity
markets, particularly for smaller technology companies, we may not have access
to new capital investment when we need to raise additional funds.

     Our future capital requirements will depend upon several factors, including
whether we are successful in developing our products and services, and our level
of expenditures for operating expenses. Our expenditures are likely to rise as
we begin our technology and business development efforts in earnest. If our
capital requirements vary materially from those currently planned, we may
require additional financing sooner than anticipated. If we cannot raise funds
on acceptable terms, we may not be able to develop our products and services,
take advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, any of which could have a material adverse effect on
our ability to develop and grow our business.

     Further, if we issue equity securities, our existing stockholders will
experience dilution of their ownership percentage, and the new equity securities
may have rights, preferences or privileges senior to those of our common stock.
If we do not obtain additional funds when needed, we could quickly cease to be a
viable going concern.

     We do not intend to declare dividends and our stock could be subject to
     volatility.

     We have never declared or paid any cash dividends on our common stock. We
presently intend to retain future earnings, if any, to finance the development
of our new business and do not expect to pay any dividends in the foreseeable
future.

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

          .    variations in the magnitude of our losses from operations from
               quarter to quarter;

          .    changes in market valuations of companies in the broadband
               infrastructure and services sectors;

          .    announcements by us or our competitors of new technology,
               products, services, significant contracts, acquisitions,
               strategic relationships, joint ventures, capital commitments or
               other material developments that affect our prospects and our
               relative competitive position in our prospective markets;

          .    our inability to locate or maintain suppliers of our planned line
               of broadband infrastructure products at prices that will allow us
               to attain profitability;

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<PAGE>

          .    product or design flaws, or our inability to bring functional
               products to market, product recalls or similar occurrences, or
               failure of a substantial market to develop for our planned
               products;

          .    additions or departures of key personnel;

          .    sales of capital stock in the future;

          .    stock liquidity or cash flow constraints; and

          .    fluctuations in stock market prices and volume, which are
               particularly common for the securities of highly volatile
               technology companies pursuing untested markets and new
               technology.

     We have attempted to transfer our obligations from our old line of business
     and if we are unsuccessful in making the transition, our business will
     suffer.

     In February 2001, we entered into an agreement with EarthLink, Inc., for
the transfer of our service obligations relating to most of our existing
customers. Approximately 50,000 of our customers were transferred to EarthLink's
Internet service on March 12, 2001. After the transfer of our existing customers
to EarthLink's service, we continue to provide Internet access service to
approximately 7,000 customers. We continue to have the obligation to provide
service to approximately 6,000 of these customers through November 2001. We have
terminated our obligation under one network services agreement and anticipate
terminating or restructuring others, which could result in significant
termination fees or other charges. We also have continuing warranty obligations,
through January 2002, relating to the Internet appliances we sold to our
customers. If we are unable to successfully complete the transition from our old
line of business, or incur significant liability related to that business in the
transition, or after we have exited the Internet appliance and service business,
our future financial results will suffer.

     Any failure of EarthLink to provide services to our former customers could
     result in liability or adverse financial consequences for our future
     business.

     EarthLink agreed to provide Internet service to most of our former Internet
appliance customers after discontinuation of that business.  If EarthLink fails
to honor its commitment and those customers are unable to have Internet access
using their Internet appliances we sold them, we could be subject to claims from
such customers that may adversely impact our future business and financial
results.

     If we are unable to meet our contractual commitments, our financial results
     may be adversely affected.

     We have entered into minimum quantity and other non-cancelable commitments
in support of our old business. As we transition out of our former consumer
business we will need to reach agreement with such parties to terminate our
contractual relationships on acceptable terms. We may be unable to meet our
commitments under our contract or reach agreement with those parties or any
other minimum quantity or other non-cancelable commitments we may enter into in
the future. This may result in renegotiation of the contracts on less favorable
terms, or we could incur contract termination fees or other charges under
existing or future contracts, that would adversely affect our financial results.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

     All of our current contracts are denominated in United States dollars and
we do not currently invest in derivative financial instruments.  However, we
invest our excess cash balances in short-term, interest bearing, investment-
grade securities, certificates of deposit or direct or guaranteed U.S.

                                       22
<PAGE>

government obligations, such as Treasury bills, that are subject to market risk.
We believe the effect on our financial position, results of operations and cash
flows as the result of any reasonably likely changes in interest rates would not
be material.

PART II.  OTHER INFORMATION.

ITEM 1.   LEGAL PROCEEDINGS

     In 2000, the Federal Trade Commission initiated an investigation of certain
of our practices in marketing our Internet appliances and related services,
including whether we were in compliance with the FTC's Trade Regulation Rule
Concerning the Sale of Mail or Telephone Merchandise. As a result of the
investigation and discussions between us and the FTC, we and the FTC staff
conducting the investigation have entered into a tentative settlement. The
settlement is in the form of a Consent Decree and Order for Injunctive Relief,
Consumer Redress, Civil Penalties, and Other Relief. If the draft Complaint and
Consent Decree are approved by the FTC and the court in which the Complaint and
Consent Decree will be filed, we, without admitting liability for any of the
matters alleged in the Complaint, will be required, among other things, to pay a
civil penalty of $100,000 for the alleged violations.

     On March 1, 2001, Spyglass, Inc. filed a lawsuit against us seeking in
excess of $300,000 in damages for the alleged breach of a contract relating to
software development by Spyglass for our discontinued business.  We have filed a
denial and counterclaim against Spyglass for breach of contract.  The case is
pending in state court in DuPage County, Illinois.

     We have commenced litigation in Austin, Texas, against Data Exchange
Corporation ("DEX") for actions arising from DEX's refusal to release to us our
remaining inventory of Internet appliances held by DEX.  The lawsuit asserts
causes of action for breach of contract and conversion.  DEX has answered the
suit and denied our claims.  The action is currently pending in the United
States District Court for the Western District of Texas, Austin Division.

     At this time, we are not involved in any other legal proceedings that our
management currently believes would be material to our business, financial
condition or results of operations.

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ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.

     (a)

     10.1      Consulting Agreement dated March 2, 2001, by and between Kent A.
               Savage and Netpliance.

     (b)       On January 18, 2001, we filed a Current Report on Form 8-K
               regarding the potential delisting of our common stock from the
               Nasdaq National Market.

               On January 23, 2001, we filed a Current Report on Form 8-K
               regarding the termination of discussions between our Board of
               Directors and a group of investors regarding a possible
               management buyout of the Company.

               No other Reports on Form 8-K were filed during the quarter for
               which this report is filed.

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                                  SIGNATURES

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

                                      NETPLIANCE, INC.


Date:  May 11, 2001                   /s/ Francis S. Webster III
                                      ------------------------------------------
                                      Francis S. Webster III
                                      President, Chief Operating Officer and
                                      Chief Financial Officer

                                       25
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                                 EXHIBIT INDEX


     10.1      Consulting Agreement dated March 2, 2001, by and between Kent A.
               Savage and Netpliance.

                                       26