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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2001

OR

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

For the transition period from  to

Commission File Number: 001-16147

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ELASTIC NETWORKS INC.(Exact name of registrant as specified in its charter)

Delaware(State or other jurisdiction of incorporation or organization)

58-2418576(I.R.S. Employer Identification No.)


6120 Windward Parkway, Suite 100, Alpharetta, Georgia(Address of principal executive offices)

30005(Zip Code)

(678) 297-3100(Registrant's telephone number, including area code)

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 / /

Elastic
Networks Inc. had 31,524,351 shares of its $.01 par value common stock outstanding as of July 25, 2001.

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|PART I  FINANCIAL INFORMATION |         | PAGE
NO.                                                                                    
|----------------------------- | ------- | --------------------------------------------------------------------------------------------
|                              | Item 1. |                                                                                             
|                              |         | Condensed Balance Sheets as of June 30, 2001 and December 31, 2000                          
|                              |         | Condensed Statements of Operations for the Three and Six Months Ended
June 30, 2001 and 2000
|                              |         | Condensed Statement of Stockholders' Equity For the Six Months Ended
June 30, 2001          
|                              |         | Condensed Statements of Cash Flows for the Six Months Ended
June 30, 2001 and 2000          
|                              |         | Notes to Condensed Financial Statements                                                     
|                              | Item 2. |                                                                                             
|                              |         | Risk Factors                                                                                
|                              | Item 3. |                                                                                             
|PART II  OTHER INFORMATION    |         |                                                                                             
|                              | Item 2. |                                                                                             
|                              | Item 4. |                                                                                             
|                              | Item 5. |                                                                                             
|                              | Item 6. |                                                                                             
|SIGNATURES                    |         | 27                                                                                          

2

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PART IFINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS.

ELASTIC NETWORKS INC.  Condensed Balance Sheets  (in thousands, except share data)  (unaudited)

|                                     |                                                                                                                                                                     | June 30,
2001                              |       | December 31,
2000 |       
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | ----------------- | ------
|Assets                               |                                                                                                                                                                     |                                            |       |                   |       
|Current assets:                      |                                                                                                                                                                     |                                            |       |                   |       
|                                     | Cash and cash equivalents                                                                                                                                           |                                            | $     | 33,144            |       
|                                     | Short-term investments                                                                                                                                              |                                            |       | 8,194             |       
|                                     | Accounts receivable, net of allowance for doubtful accounts
of $209 and $90                                                                                         |                                            |       | 5,830             |       
|                                     | Inventories                                                                                                                                                         |                                            |       | 13,136            |       
|                                     | Note receivable                                                                                                                                                     |                                            |       |                  |       
|                                     | Other current assets                                                                                                                                                |                                            |       | 2,140             |       
|                                     |                                                                                                                                                                     |                                            |       |                   |       
|                                     |                                                                                                                                                                     | Total current assets                       |       |                   | 62,444
|Property and equipment, net          |                                                                                                                                                                     |                                            | 4,410 |                   |       
|Other assets                         |                                                                                                                                                                     |                                            | 102   |                   |       
|                                     |                                                                                                                                                                     |                                            |       |                   |       
|                                     |                                                                                                                                                                     | Total assets                               |       | $                 | 66,956
|                                     |                                                                                                                                                                     |                                            |       |                   |       
|Liabilities and Stockholders' Equity |                                                                                                                                                                     |                                            |       |                   |       
|Current liabilities:                 |                                                                                                                                                                     |                                            |       |                   |       
|                                     | Accounts payable                                                                                                                                                    |                                            | $     | 13,086            |       
|                                     | Accrued liabilities                                                                                                                                                 |                                            |       | 5,317             |       
|                                     | Deferred revenues                                                                                                                                                   |                                            |       | 774               |       
|                                     | Capital lease obligations                                                                                                                                           |                                            |       | 227               |       
|                                     |                                                                                                                                                                     |                                            |       |                   |       
|                                     |                                                                                                                                                                     | Total current liabilities                  |       |                   | 19,404
|Deferred revenues, long-term         |                                                                                                                                                                     |                                            | 337   |                   |       
|Capital lease obligations, long-term |                                                                                                                                                                     |                                            | 192   |                   |       
|Commitments and contingencies        |                                                                                                                                                                     |                                            |      |                   |       
|Stockholders' equity:                |                                                                                                                                                                     |                                            |       |                   |       
|                                     | Preferred stock, par value $0.01; 25,000,000 shares authorized, 0 shares issued and outstanding                                                                     |                                            |       |                  |       
|                                     | Common stock, par value $0.01; 100,000,000 shares authorized, 31,486,010 shares and 31,329,470 shares issued and outstanding at June 30, 2001 and December 31, 2000 |                                            |       | 314               |       
|                                     | Additional paid-in capital                                                                                                                                          |                                            |       | 130,792           |       
|                                     | Deferred stock compensation                                                                                                                                         |                                            |       | (1,339            | )     
|                                     | Accumulated deficit                                                                                                                                                 |                                            |       | (82,744           | )     
|                                     |                                                                                                                                                                     |                                            |       |                   |       
|                                     |                                                                                                                                                                     | Total stockholders' equity                 |       |                   | 47,023
|                                     |                                                                                                                                                                     |                                            |       |                   |       
|                                     |                                                                                                                                                                     | Total liabilities and stockholders' equity |       | $                 | 66,956
|                                     |                                                                                                                                                                     |                                            |       |                   |       

The accompanying notes are an integral part of these condensed financial statements.

3

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ELASTIC NETWORKS INC.  Condensed Statements of Operations  (in thousands, except per share data)  (unaudited)

|                                                                                      |                            | Three Months Ended June 30, |                | Six Months Ended
June 30, |       
|------------------------------------------------------------------------------------- | -------------------------- | --------------------------- | -------------- | ------------------------- | ------
|
|Net revenues                                                                          |                            | $                           | 8,000          |                           | $     
|Cost of revenues                                                                      |                            |                             | 6,807          |                           |       
|Charges related to excess inventory on hand and on order and restructuring charges    |                            |                             |               |                           |       
|                                                                                      |                            |                             |                |                           |       
|Gross profit (loss)                                                                   |                            |                             | 1,193          |                           |       
|Operating expenses: (1)                                                               |                            |                             |                |                           |       
|                                                                                      | Sales and marketing        |                             |                | 3,032                     |       
|                                                                                      | Research and development   |                             |                | 2,978                     |       
|                                                                                      | General and administrative |                             |                | 3,573                     |       
|                                                                                      |                            |                             |                |                           |       
|                                                                                      |                            | Total operating expenses    |                |                           | 9,583 
|                                                                                      |                            |                             |                |                           |       
|                                                                                      |                            |                             | Operating loss |                           |       
|Other income (expense), net                                                           |                            |                             | 541            |                           |       
|                                                                                      |                            |                             |                |                           |       
|                                                                                      |                            | Net loss                    |                |                           | (7,849
|Accretion of Series A preferred stock                                                 |                            |                             |               |                           |       
|                                                                                      |                            |                             |                |                           |       
|Net loss attributed to common stockholders                                            |                            | $                           | (7,849         | )                         | $     
|                                                                                      |                            |                             |                |                           |       
|Basic and diluted net loss per common share                                           |                            | $                           | (0.25          | )                         | $     
|                                                                                      |                            |                             |                |                           |       
|Weighted average shares used in computing basic and diluted net loss per common share |                            |                             | 31,467         |                           |       
|                                                                                      |                            |                             |                |                           |       

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The accompanying notes are an integral part of these condensed financial statements.

4

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ELASTIC NETWORKS INC.  Condensed Statement of Stockholders' Equity  (in thousands, except share data)  (unaudited)

|                                            |  | Common Stock |  |      |  |          |   |         |   |          |  
|------------------------------------------- |  | ------------ |  | ---- |  | -------- | - | ------- | - | -------- | -
|
|
|Balance at December 31, 2000                |  | 31,329,470   |  | $313 |  | $129,802 |   | $(2,978 | ) | $(51,175 | )
|Net loss                                    |  |              |  |      |  |          |   |         |   | (31,569  | )
|Employee stock options exercised            |  | 156,540      |  | 1    |  | 323      |   |         |   |          |  
|Deferred stock compensation                 |  |              |  |      |  | (1,348   | ) | 1,348   |   |          |  
|Amortization of deferred stock Compensation |  |              |  |      |  |          |   | 291     |   |          |  
|Nortel Networks options payout              |  |              |  |      |  | 2,214    |   |         |   |          |  
|Other                                       |  |              |  |      |  | (199     | ) |         |   |          |  
|                                            |  |              |  |      |  |          |   |         |   |          |  
|Balance at June 30, 2001                    |  | 31,486,010   |  | $314 |  | $130,792 |   | $(1,339 | ) | $(82,744 | )
|                                            |  |              |  |      |  |          |   |         |   |          |  

The accompanying notes are an integral part of these condensed financial statements.

5

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ELASTIC NETWORKS INC.  Condensed Statements of Cash Flows  (in thousands, except share data)  (unaudited)

|                                                             |                                                                             | Six Months Ended June 30,                                                                                     |                                                    
|------------------------------------------------------------ | --------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------
|
|Cash flows from operating activities:                        |                                                                             |                                                                                                               |                                                    
|                                                             | Net loss                                                                    |                                                                                                               | $                                                  
|                                                             | Adjustments to reconcile net loss to net cash used in operating activities: |                                                                                                               |                                                    
|                                                             |                                                                             | Charges related to excess inventory on hand and on order, note receivable write-off and restructuring charges |                                                    
|                                                             |                                                                             | Depreciation and amortization                                                                                 |                                                    
|                                                             |                                                                             | Amortization of deferred stock compensation                                                                   |                                                    
|                                                             |                                                                             | Nortel Networks options payout                                                                                |                                                    
|                                                             |                                                                             | Issuance of common stock options and warrants                                                                 |                                                    
|                                                             | Changes in assets and liabilities:                                          |                                                                                                               |                                                    
|                                                             |                                                                             | Accounts receivable                                                                                           |                                                    
|                                                             |                                                                             | Note receivable                                                                                               |                                                    
|                                                             |                                                                             | Inventories                                                                                                   |                                                    
|                                                             |                                                                             | Accounts payable                                                                                              |                                                    
|                                                             |                                                                             | Accrued liabilities                                                                                           |                                                    
|                                                             |                                                                             | Other                                                                                                         |                                                    
|                                                             |                                                                             |                                                                                                               |                                                    
|                                                             |                                                                             |                                                                                                               | Net cash used in operating activities              
|                                                             |                                                                             |                                                                                                               |                                                    
|Cash flows from investing activities:                        |                                                                             |                                                                                                               |                                                    
|                                                             | Purchases of property and equipment                                         |                                                                                                               |                                                    
|                                                             | Proceeds from sale of short-term investments                                |                                                                                                               |                                                    
|                                                             | Purchases of short-term investments                                         |                                                                                                               |                                                    
|                                                             |                                                                             |                                                                                                               |                                                    
|                                                             |                                                                             |                                                                                                               | Net cash provided by (used in) investing activities
|                                                             |                                                                             |                                                                                                               |                                                    
|Cash flows from financing activities:                        |                                                                             |                                                                                                               |                                                    
|                                                             |                                                                             | Cash proceeds from issuance of common and preferred stock                                                     |                                                    
|                                                             |                                                                             | Payment of note receivable attributable to Series A preferred shares issuance                                 |                                                    
|                                                             |                                                                             | Other                                                                                                         |                                                    
|                                                             |                                                                             |                                                                                                               |                                                    
|                                                             |                                                                             |                                                                                                               | Net cash provided by financing activities          
|                                                             |                                                                             |                                                                                                               |                                                    
|                                                             |                                                                             |                                                                                                               | Net decrease in cash and cash equivalents          
|Cash and cash equivalents, beginning of period               |                                                                             |                                                                                                               | 48,195                                             
|                                                             |                                                                             |                                                                                                               |                                                    
|Cash and cash equivalents, end of period                     |                                                                             | $                                                                                                             | 33,144                                             
|                                                             |                                                                             |                                                                                                               |                                                    
|Supplemental schedule of investing and financing activities: |                                                                             |                                                                                                               |                                                    
|                                                             |                                                                             | Cash paid during the period for interest                                                                      |                                                    
|                                                             |                                                                             |                                                                                                               |                                                    
|                                                             |                                                                             | Issuance of stock options and warrants for consulting services                                                |                                                    
|                                                             |                                                                             |                                                                                                               |                                                    
|                                                             |                                                                             | Capital lease additions                                                                                       |                                                    
|                                                             |                                                                             |                                                                                                               |                                                    

The accompanying notes are an integral part of these condensed financial statements.

6

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ELASTIC NETWORKS INC.  NOTES TO CONDENSED FINANCIAL STATEMENTS  (in thousands, except share and per share data)  (unaudited)

NOTE 1.  BASIS OF PREPARATION

The accompanying condensed financial statements included herein have been prepared by Elastic Networks Inc. (the "Company") without audit, in accordance
with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC"). Footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America for complete financial
statements have been condensed or omitted pursuant to such rules and regulations.

This
quarterly report and the accompanying condensed financial statements should be read in conjunction with the Company's audited financial statements and notes thereto presented in
its Annual Report on Form 10-K for the fiscal year ended December 31, 2000 (the "2000 Annual Report"). Footnotes, which would substantially duplicate the disclosures in the
Company's audited financial statements for the year ended December 31, 2000 contained in the 2000 Annual Report, have been omitted.

In
the opinion of management, the condensed financial statements included herein contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly the
financial position of the Company as of June 30, 2001 and the results of operations for the three and six months ended June 30, 2001 and 2000 and cash flows for the six months ended
June 30, 2001 and 2000. Operating results for the three and six months ended June 30, 2001 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2001.

NOTE 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

REVENUE RECOGNITION

The Company generally recognizes revenues upon shipment depending on contract terms and conditions if collectibility is reasonably assured, pricing is fixed
and determinable, and returns are reasonably estimated. No revenues are recognized on products shipped on a trial basis until products are fully accepted by the customer. Estimated sales returns,
based on historical experience by product, are recorded at the time the product revenues are recognized. Certain technology license revenues are recognized ratably over the term of the related
agreement (see note 12 in the Company's 2000 Annual Report).

Consulting
services, principally, installation and training revenues are recognized as the services are completed. These services are typically performed under separate service
agreements and are usually performed on a time and material basis. Such services primarily consist of implementation services related to the installation and deployment of the Company's products.

Revenues
are generally recognized upon shipment of the equipment. In other transactions where the Company holds the inventory but invoices the customer, the Company recognizes
revenues when the following conditions are met: the equipment is complete, ready for shipment and segregated from other inventory; the Company has no further significant performance obligations in
connection with the completion of the transaction; the commitment and delivery schedule is fixed; the customer requested the transaction be completed on this basis; and the risks of ownership have
passed to the customer. There were no revenues recognized from these transactions for the three months or six months ended June 30, 2001 and 2000. Accounts receivable relating to these
transactions of $0.0 and $1.2 million was included in total accounts receivable at June 30, 2001 and December 31, 2000, respectively.

7

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NET LOSS PER COMMON SHARE

Basic and diluted net loss per common share are presented in conformity with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share,
 for all periods presented. Basic and diluted net loss per common share were computed on the basis of weighted-average shares
outstanding.

For
all periods presented, dilutive securities included options, warrants and contingent stock related to Series A and B redeemable convertible participating preferred stock.
Potentially dilutive securities totaling 121,105 and 2,576,190 for the quarters ended June 30, 2001 and 2000 and 1,111,144 and 2,192,890 for the six months ended June 30, 2001 and 2000,
respectively were excluded from historical diluted net loss per common share because of their anti-dilutive effect.

RECENT PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141,Business
Combinations. This statement supersedes Accounting Principles Board ("APB") Opinion No. 16,Business Combinationsand
FASB Statement No. 38,Accounting for Preacquisition Contingencies of Purchased Enterprises. It revises the standards for accounting treatment
for business combinations by requiring the use of purchase accounting and prohibiting the use of the pooling-of-interests method for all business combinations initiated after
June 30, 2001. The Company does not expect the adoption of SFAS No. 141 to have a material impact on the financial reporting and related disclosures of the Company.

In
July 2001, the FASB issued SFAS No. 142,Goodwill and Other Intangible Assets. This statement supersedes APB Opinion
No. 17,Accounting for Intangible Assets. It revises the standards for accounting for goodwill and other intangible assets by not allowing
amortization of goodwill and establishing accounting for impairment of goodwill and other intangible assets. In addition, the standard includes provisions for reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the
identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 is required to be applied starting with fiscal years beginning after
December 15, 2001. To date, the Company has not entered into any business combinations and has no goodwill or intangible assets that would be subject to this statement. Accordingly, the
adoption of SFAS No. 142 should not have any impact on the financial reporting and related disclosures of the Company.

In
September 2000, the FASB issued SFAS No. 140,Accounting for Transfers and Servicing of Assets and Extinguishments of
Liabilities. This statement replaces FASB Statement No. 125,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain additional disclosures, but
it carries over most of the provisions of SFAS 125 without reconsideration. SFAS 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. The adoption of this pronouncement did not have a material impact on the Company's results of operations or its financial position.

8

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In
June 1998, the FASB issued SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, which
established accounting and reporting standards for derivative instruments and hedging activities. It requires an entity to measure all derivatives at fair value and to recognize them in the balance
sheet as an asset or liability, depending on the entity's rights or obligations under the applicable derivative contract. In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities Deferral of the effective date of FASB Statement No. 133, which deferred the
effective date of SFAS No. 133 until fiscal quarters of all fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities, which amends the accounting and reporting standards of SFAS No. 133
for certain derivative instruments and certain hedging activities. The Company, to date, has not engaged in derivative or hedging activities, and accordingly the adoption of SFAS No. 133 on
January 1, 2001 did not have any impact on the balance sheet of the Company.

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current year presentation.

NOTE 3.  INVENTORIES

Inventories, net of allowances, consist of the following:

June 30,
2001

December 31,
2000Raw materials

$1,862

$512Finished goods

11,274

5,955Total

$13,136

$6,467


The
allowances for inventories were $10.9 million and $1.7 million at June 30, 2001 and December 31, 2000, respectively.

9

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NOTE 4.  SEGMENT INFORMATION

The Company operates in one reportable business segment, to develop technology and products to provide high-speed access over copper wire
infrastructure.

GEOGRAPHIC INFORMATION

The Company's headquarters and its operations are located in the U.S. The Company's research and development activities are conducted in the U.S. The Company
conducts its sales, marketing and customer service activities throughout the world including the Company's international office located in Hong Kong, China. Geographic long-lived assets
information is based on the physical location of the assets at the end of each period. Geographic revenue information is based on the location of the end customer. Identifiable long-lived
assets (principally property and equipment) by geographic areas:

June 30,
2001

December 31,
2000Long-lived assetsU.S.

$
4,410

$
3,375


Revenues
by geographic region are as follows:

Three Months Ended June 30,

Six Months Ended
June 30,2001

2000

2001

2000Revenues:U.S.

$
7,893

$
7,270

$
11,924

$
12,468Asia


107


776


1,562


1,467Other





458


157


758Total Revenues

$
8,000

$
8,504

$
13,643

$
14,693


NOTE 5.  RELATED PARTY TRANSACTIONS

The following tables summarize related party transactions:

June 30,
2001

December 31,
2000Receivables from Nortel Networks

$
5,054

$
1,082Payables to Nortel Networks


808


360


Three Months Ended June 30,

Six Months Ended June 30,2001

2000

2001

2000Sales to Nortel Networks

$
6,582

$
2,205

$
9,426

$
3,158


10

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

Forward-Looking Statements

Certain of the statements contained in this Report are forward-looking statements (rather than historical facts) that are subject to risks and uncertainties
that could cause actual results to differ materially from those described herein. With respect to such forward-looking statements, Elastic Networks Inc. (the "Company") seeks the protections
afforded by the Private Securities Litigation Reform Act of 1995. Additional information concerning these risks and uncertainties is set forth in the section titled "Risk Factors" on page 16 of
this Report. The risk factor discussion contained therein is intended to identify certain of the principal factors that could cause actual results to differ materially from those described in the
forward-looking statements included herein. It is not intended to represent a complete list of all risks and uncertainties inherent in the Company's business.

Readers
are also urged to carefully read and consider this Management's Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the Company's
financial statements and the related notes and Risk Factors included herein and in the Company's Annual Report on Form-10K for the year ended December 31, 2000 and other reports and
filings made with the Securities and Exchange Commission ("SEC").

Overview

The Company designs, develops and markets high-speed, broadband communications products which enable service providers to deliver easy to deploy
and cost-effective broadband access solutions to their customers over the existing copper telephone wire infrastructure. The Company designs products based on its patented EtherLoop
technology to deliver a next generation access solution. EtherLoop's advantages overcome many of the deployment, performance, cost and quality of service limitations of conventional Digital Subscriber
Line ("DSL") technologies.

The
Company was formed in January 1997 as a division of Nortel Networks, and through mid 1999, its operating activities related primarily to developing its EtherLoop technology
and complementary software, building and testing prototype products, building its technical support infrastructure, staffing its sales and marketing organization and establishing relationships with
its customers. In mid 1999, the Company commenced shipment of its commercial products and has continued making investments to grow its business.

The
Company's 2001 revenues have been generated principally from sales of its first and second generation DSL access multiplexers ("DSLAMs"), which are known as BitStorm
DSLAMs and which connect broadband modem signals with the Internet, its StormPort broadband modem, and to a lesser extent, its complementary software. Sales of the Company's Storm System family
of products in the second quarter of 2001 generated the majority of the Company's revenues for the quarter. This trend is expected to continue in 2001 as the transition from the Company's first
generation DSLAMs continues. Sales of the Company's IP DSLAMs, servers and broadband modems accounted, in the aggregate, for approximately 99% and 90% of total revenues for the quarters ended
June 30, 2001 and 2000, respectively and 87% and 86% of total revenues for the six months ended June 30, 2001 and 2000, respectively.

The
Company follows a revenue diversification strategy consisting of focusing on the carrier, Multi Tenant Unit ("MTU") and international markets. As the Company continues to expand
its customer relationships in 2001, it anticipates existing customers will represent a smaller percentage of its revenues in the remaining quarters of 2001.

11

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The Company targets its sales efforts to various categories of service providers operating in the market for high-speed access, both in the U.S. and internationally. To
date, customer installations have ranged from in-building applications, including hotels, apartment buildings and university campuses, to service providers' central office locations used
to reach both business and residential users.

As
part of its ongoing goal to achieve and increase profitability, the Company recently closed its Toronto, Canada office. As of July 25, 2001, the Hong Kong, China office
remains a viable part of the Company's international operations while the Canadian customers are serviced from our U.S. location. To date, the Company's international sales have been denominated in
U.S. dollars and, accordingly, it has not been materially exposed to fluctuations in non-U.S. currency exchange rates. In the future, a portion of its international sales may be
denominated in currencies other than U.S. dollars, which would expose the Company to gains and losses upon exchange rate fluctuations.

The
Company's positive gross margin for the quarter ended June 30, 2001 was primarily the result of the transition of sales from the first generation product line to the Storm
System product line. The Company expects that its gross margins will increase in the future as the Company continues to lower
the cost of its existing products, further offers the sale of its Storm System family of products and related chipsets, and increases its licensing revenues.

As
of July 25, 2001, the Company employed approximately 109 full time employees, which reflects a decrease of 43 employees from April 30, 2001 as a result of a
restructuring of the Company's employee base in July 2001.

Stock-based
compensation reflected in the Company's operating expenses includes the amortization of stock compensation charges resulting from the grant of stock options to employees
with exercise or sales prices which may be deemed for accounting purposes to be below the fair market value of the Company's common stock on the date of grant and compensation expense associated with
the grant of stock options to non-employees. Deferred compensation amounts are amortized over the vesting periods of the applicable options, which are generally four years. The
compensation expense associated with options granted to non-employees is recorded at the time services are provided.

In
fulfillment of compensation arrangements between Nortel Networks and some of the Company's employees relating to their prior employment with Nortel Networks, Nortel Networks has
agreed to pay these employees, if they are still working for the Company at the time of payment, an aggregate of approximately $13.4 million in cash. On October 21, 2000, the employees
received a payment from Nortel Networks of $8.9 million. Nortel Networks will make an additional payment of approximately $4.5 million on the first anniversary of that date. In
connection with these arrangements, the Company recorded compensation expense for the six months ended June 30, 2001 of $2.2 million and will record additional compensation expense of
approximately $1.1 million in 2001. The Company will record capital contributions from Nortel Networks in equivalent amounts.

12

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RESULTS OF OPERATIONS

The unaudited table below shows operating data, as a percentage of revenues, for the periods indicated:

|                                                                                   |                            | Three Months Ended June 30, |                | Six Months Ended June 30, |     
|---------------------------------------------------------------------------------- | -------------------------- | --------------------------- | -------------- | ------------------------- | ----
|
|Total revenues                                                                     |                            | 100                         | %              | 100                       | %   
|Cost of revenues                                                                   |                            | 85                          |                | 95                        |     
|Charges related to excess inventory on hand and on order
and restructuring charges |                            |                            |                |                          |     
|                                                                                   |                            |                             |                |                           |     
|                                                                                   |                            | Gross profit (loss)         |                | 15                        |     
|Operating expenses: (1)                                                            |                            |                             |                |                           |     
|                                                                                   | Sales and marketing        |                             | 38             |                           | 43  
|                                                                                   | Research and development   |                             | 37             |                           | 39  
|                                                                                   | General and administrative |                             | 45             |                           | 12  
|                                                                                   |                            |                             |                |                           |     
|                                                                                   |                            | Total operating expenses    |                | 120                       |     
|                                                                                   |                            |                             |                |                           |     
|                                                                                   |                            |                             | Operating loss |                           | (105
|Other income (expense), net                                                        |                            | 7                           |                | 0                         |     
|                                                                                   |                            |                             |                |                           |     
|Net loss                                                                           |                            | (98                         | %)             | (89                       | %)  
|                                                                                   |                            |                             |                |                           |     

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THREE AND SIX MONTHS ENDED JUNE 30, 2001 VS. THREE AND SIX MONTHS ENDED JUNE 30, 2000

Total Revenues.Revenues decreased from $8.5 million in the quarter ended June 30, 2000 to
$8.0 million in the same period for 2001. During the first six months of 2001, the Company generated revenues of $13.6 million, a decrease of 7% from the prior year's same period amount
of $14.7 million. This decrease was primarily due to continued weakening economic conditions that have affected overall capital spending in the telecommunications industry. During the three
months ended June 30, 2001 and 2000, the Company generated revenues from international sales of $0.3 million and $1.2 million, respectively. During the six months ended
June 30, 2001 and 2000, the Company generated revenues from international sales of $1.7 million and $2.2 million, respectively.

Gross Profit (Loss).Gross profit increased from $0.4 million in the quarter ended June 30, 2000 to
$1.2 million in the same period for 2001. The Company introduced its second-generation chipset in the fourth quarter of 2000. Sales of products encompassing this new technology in higher
volume, along with current product platform cost reductions, resulted in improved gross margins in the second quarter of 2001. The Company's gross profit decreased from a profit of $0.6 million
for the six months ended June 30, 2000 to a loss of $10.5 million for the same period of 2001. The decline in year-to-date gross profit, in absolute dollars and
as a percentage of revenues, was primarily the result of the charges related to excess inventory on hand and on order in the amount of $11.9 million taken during the quarter ended
March 31, 2001.

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Sales And Marketing.Sales and marketing expenses decreased from $3.7 million in the quarter ended
June 30, 2000 to $3.0 million in the same period for 2001. This decrease was primarily a result of decreases in staffing for marketing, account management, customer product trials,
customer support and direct sales as a result of the Company's overall cost restructuring efforts. For the six-month periods ended June 30, sales and marketing expenses increased
from $6.2 million in 2000 to $7.0 million in 2001. This increase in sales and marketing expenses was the result of the Company's increased investment in international operations during
the first quarter of 2001. Non-cash stock compensation expense was $0.1 million and $0.02 million for the quarters ended June 30, 2000 and 2001, respectively and
$0.1 million and $0.05 million for the six-month periods of 2000 and 2001, respectively.

Research And Development.Research and development expenses decreased from $3.3 million in the quarter ended
June 30, 2000 to $3.0 million in the same period for 2001. This decrease was primarily a result of a decrease in personnel related costs and engineering charges related to product
development. The increase from $5.4 million for the six month period ended June 30, 2000 to $6.5 million for the same period in 2001 was primarily a result of an increase in
depreciation expense related to lab equipment and prototype costs associated with ongoing technological development incurred during 2001. Non-cash stock compensation expense was
$0.6 million and $0.03 million for the quarters ended June 30, 2000 and 2001, respectively and $0.7 million and $0.05 million for the six month periods of 2000 and
2001.

General And Administrative.General and administrative expenses increased from $1.0 million for the quarter
ended June 30, 2000 to $3.6 million in the same period for 2001. This increase was primarily the result of non-cash stock compensation expense of $1.1 million arising
from payouts from Nortel Networks related to compensation arrangements with key executives, and increases in expenditures related to depreciation expense, office rent, and other facility-related
expenditures. For the six month periods ended June 30, 2000 and 2001, general and administrative expenses increased from $2.2 million to $8.9 million, respectively. This increase
was primarily the result of a write-off of an uncollectible note receivable for $2.1 million and non-cash stock compensation expense of $2.2 million arising from
payouts from Nortel Networks related to compensation arrangements with key executives. The remaining increases resulted from increased personnel related costs and increased expenditures on facilities,
legal, accounting, information systems and consulting fees.

Other Income (Expense), Net.Other income (expense), net increased from ($0.03) million in the quarter ended
June 30, 2000 to $0.5 million in the same period for 2001, and increased from $0.05 million for the six month period ended June 30, 2000 to $1.4 million in the same
period for 2001, resulting, in each case, primarily from an increase in interest income.

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LIQUIDITY AND CAPITAL RESOURCES

On October 4, 2000, the Company completed its Initial Public Offering ("IPO") for the sale of 6.8 million shares of Common Stock at a price to
the public of $13.00 per share, which resulted in proceeds of $80.3 million to the Company, net of aggregate expenses. Upon the closing of the IPO, all shares of the Company's Series A
and B redeemable convertible participating preferred stock were converted into an aggregate of 9.1 million shares of Common Stock. At June 30, 2001, the Company had cash and cash
equivalents and short-term investments of $41.3 million.

Cash
used in operating activities was $25.5 million for the six months ended June 30, 2001 and $22.2 million for the same period of 2000. The increase in cash
used for operating activities was primarily due to increases in inventories and to fund net losses. This increase was partially offset by $14.0 million of non-cash charges related
to excess inventory on hand and on order, the write-off of a note receivable, and restructuring charges, as well as an increase of $2.2 million in accounts payable and a decrease of
$2.2 million in accounts receivable.

Cash
provided by investing activities was $10.3 million for the six months ended June 30, 2001 and cash used by investing activities was $0.9 million for the same
period of 2000. The increase in cash provided by investing activities was primarily due to the sale of $20.9 million of short-term investments due to interest earnings potential in
cash investments exceeding the short-term earnings rate during the quarter ended June 30, 2001. The increase was partially offset by the utilization of $1.9 million for
capital expenditures and $8.7 million for the purchase of short-term investments during the six months ended June 30, 2001.

Cash
provided by financing activities was $0.2 million for the six months ended June 30, 2001 and $22.8 million for the same period of 2000. The decrease in cash
provided by financing activities was primarily due to $20.9 million in cash received during the quarter ended March 31, 2000 in connection with the issuance of Series B redeemable
convertible participating preferred stock, which was not issued in the same period of 2001.

The
Company's future capital requirements will depend upon many factors, including sales of its products and the timing of research and product development efforts. The Company
expects to continue to expend amounts on property and equipment related to the facility infrastructure, computer equipment, and for its research and development laboratory and test equipment to
support on-going research and development operations. At June 30, 2001, the Company had no material commitments other than obligations under its operating and capital leases and
product manufacturing and purchase agreements. There are potential additional exposures from existing contract manufacturer commitments and inventory obsolescence. The Company believes its cash and
cash equivalent balances and short-term investments will be sufficient to satisfy its cash requirements for at least the next twelve months. The Company intends to invest its cash in
excess of current operating requirements in short-term, interest-bearing, investment-grade securities.

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RISK FACTORS

WE HAVE A SHORT OPERATING HISTORY, WHICH MAY MAKE IT DIFFICULT TO ACCURATELY FORECAST OUR FUTURE REVENUES AND OTHER OPERATING RESULTS.

We
only began selling our products in mid 1999. As a result, we have only a limited operating history upon which you may evaluate our business and prospects. Our limited operating
history may make it difficult or impossible for analysts or investors to accurately forecast our future revenues and other operating results. Furthermore, if we do not meet or exceed the forecasts and
expectations of analysts and investors regarding our future revenues and other operating results, the price of our Common Stock could decline substantially.

WE HAVE INCURRED NET LOSSES SINCE WE WERE FORMED AND EXPECT TO INCUR FUTURE LOSSES.

From inception through June 30, 2001, we incurred net losses totaling approximately $111 million. We expect to continue to make substantial
expenditures for sales and marketing, product development and other purposes, which may be fixed in the short term. As a result, we expect to continue to incur losses in 2001, as well as in future
years. Our ability to increase revenues, and achieve and maintain profitability in the future, will primarily depend on our ability to increase sales of our products, reduce production and other costs
and successfully introduce new and enhanced versions of our existing products into the marketplace. We cannot assure you that we will be able to increase our revenues at a rate that equals or exceeds
expenditures. Our failure to do so will result in our incurring additional losses.

WE EXPECT OUR OPERATING RESULTS TO FLUCTUATE, WHICH MAY CAUSE OUR STOCK PRICE TO DECLINE.

Our quarterly and annual operating results are likely to fluctuate significantly in the future due to a variety of factors, many of which are outside of our
control. Therefore, you should not rely on our
historical operating results as an indicator of future performance. Our results of operations could fluctuate due to the following material factors:



WE DEPEND ON A SMALL NUMBER OF CUSTOMERS AND THE LOSS OF, OR REDUCTION IN PURCHASES FROM ANY ONE OF THEM COULD SIGNIFICANTLY HARM OUR BUSINESS.

We derive a substantial portion of our revenues, and expect to continue to derive a substantial portion of our revenues in the near future, from sales to a
limited number of customers. Unless and until we further diversify and expand our customer base, our success will depend significantly upon the timing and size of future purchase orders, if any, from
our largest customers, as well as their product requirements, financial and operational success, and, in particular, the successful deployment of services using our products. The loss of any one or
more of these customers, significant changes in their product requirements, delays of significant orders or the occurrence of any sales fluctuations of our or our customers' products could reduce our
revenues.

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A PORTION OF OUR BUSINESS IS GENERATED BY DEMAND FROM NEW AND EMERGING SERVICE PROVIDERS, AND THEIR INABILITY TO OBTAIN CAPITAL OR FINANCING COULD CAUSE THEM TO REDUCE OR
DISCONTINUE THE PURCHASE OF OUR PRODUCTS AT ANY TIME.

Many of the companies that currently deploy our products, or that may do so in the future, are new and emerging and have largely unproven business models.
These companies require substantial capital for the development, construction and expansion of their businesses. Financing may not be available to these companies or our other customers on favorable
terms, if at all. To the extent that these companies are unable to obtain the financing they need, our ability to make future sales to these customers directly or through our distributors could be
harmed. In addition, to the extent we choose to provide financing to these customers, we will be subject to additional financial risk, which could reduce our profitability.

WE ONLY OFFER A LIMITED NUMBER OF PRODUCTS AND THE FAILURE OF ANY ONE OF THEM TO ACHIEVE WIDESPREAD MARKET ACCEPTANCE WOULD SIGNIFICANTLY HARM OUR RESULTS OF OPERATIONS.

We derive substantially all of our revenues from sales of a limited number of high-speed access products. The failure of any of our product
offerings to achieve and maintain a meaningful level of market penetration and customer satisfaction would harm our revenues.

In
addition, we only began selling our products in mid 1999, and cannot yet predict whether they will gain widespread market acceptance. Even if our customers do purchase our products
in meaningful quantities, due to the variety and complexity of the environments in which these customers operate, our products may not operate as expected. This could result in cancelled orders,
delays in installation and increased expenses. In addition, the success of competing products and technologies, pricing pressures or manufacturing difficulties could further reduce our profitability
and the price of our Common Stock.

THE FAILURE OF DSL TECHNOLOGY TO ACHIEVE WIDESPREAD MARKET PENETRATION WOULD NEGATIVELY IMPACT DEMAND FOR OUR PRODUCTS.

Because our products are based on the use of copper telephone wires, and because there are physical limits to the speed and distance over which data can be
transmitted over these types of wires, our products may not be a viable solution for some potential customers. Some of our competitors currently offer products based on directly competing technologies
that do not have these limitations. Additionally, in the future our competitors may develop transmission media and technologies other than DSL that provide faster access, higher reliability or are
more cost effective for some of our existing and potential customers.

If
any of these technologies are adopted or implemented in our market, sales of our products could decline and our market share and profitability could be reduced.

WE DEPEND ON DISTRIBUTORS AND RESELLERS FOR SALES, AND IF ANY OF THEM DO NOT PERFORM AS EXPECTED, WE COULD EXPERIENCE LOWER THAN EXPECTED SALES.

Our success depends, in part, upon distribution and reseller arrangements, including our current arrangements with Nortel Networks. These arrangements are
relatively new, and we cannot accurately predict whether significant recurring revenues will be generated from these arrangements. Our sales and distribution partners may not market, sell or
distribute our products, or perform any of their other obligations, as we expect, in which case we may not desire to maintain these arrangements, or be able to develop successful replacements. In the
event that any of these arrangements are terminated or are otherwise unsuccessful, sales of our products could be harmed.

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OUR DEPENDENCE ON SINGLE SOURCE SUPPLIERS EXPOSES US TO SUPPLY INTERRUPTION RISKS, WHICH COULD HARM OUR SALES OR INCREASE OUR COSTS.

Although we generally use standard parts and components for our products, our products contain several key components that are purchased from single source
suppliers: line driver chips from Texas Instruments Incorporated, power supplies from Astec America Inc. and system processor chips from Motorola, Inc. We do not have written agreements
with our single source suppliers. Our reliance on the suppliers of these components exposes us to potential production difficulties and quality variations due to increased third-party demand or
supplier related issues. If these suppliers are unable to meet component requirements, we will be forced to seek alternative production sources, which could negatively impact our costs and the timely
delivery of our products. Alternate suppliers may not meet our quantity requirements or quality standards. Our inability to obtain sufficient quantities of these components, or components that meet
our quality standards, may result in delays or reductions in product shipments, which could harm our reputation and reduce our profitability.

OUR DEPENDENCE ON TWO CONTRACT MANUFACTURERS COULD RESULT IN PRODUCT DELIVERY DELAYS.

We currently use two contract manufacturers, Sanmina Corporation and Solectron Corporation, to build some of our printed circuit boards, chassis and
subassemblies and, in most cases, to complete final assembly and testing of our products. Our current reliance on two manufacturers could result in the absence of adequate capacity to meet our
customers' needs. In addition, we could experience unavailability of, or interruptions in, access to certain process technologies, as well as reduced control
over delivery schedules, manufacturing yields, quality and costs. It is also possible that Sanmina's or Solectron's manufacturing capabilities may not be available to us when needed, or that they may
not be in a position to satisfy our production requirements at acceptable prices and on a timely basis, if at all. If Sanmina or Solectron are unable or unwilling to continue manufacturing our
components in required volumes, or to our quality specifications, or if we develop new technologies requiring components which Sanmina or Solectron are incapable of manufacturing, we will have to
identify acceptable alternative manufacturers. Alternative manufacturers, however, may not be available. Any significant interruption in the supply of products could result in our inability to
adequately meet our customers' demands, which in turn could harm our sales.

WE ORDER OUR PRODUCTS FROM OUR SUPPLIERS IN ADVANCE OF CUSTOMER ORDERS AND A DELAY, DEFERRAL OR CANCELLATION IN ANY OF SUCH CUSTOMER ORDERS COULD NEGATIVELY IMPACT OUR
INVENTORY AND HARM OUR PROFITABILITY.

As part of our inventory planning, we frequently pay certain suppliers well in advance of receipt of customer orders and enter into purchase commitments with
vendors to ensure products are available to meet forecasted customer demand. The market for telecommunications products is characterized by rapid technological advances, a high degree of volatility
and the frequent introduction of new products. Accordingly, if we fail to accurately forecast customer demand for our products, or if our customers delay, defer or cancel their orders for our
products, we could experience a decline in sales of products that we have committed to purchase. If we cannot change or be released from the purchase commitments, we could incur significant costs from
the purchase of raw material components acquired for the manufacturing of these products, as well as other restructuring and inventory-related charges. We also face the risk of ordering too many
products since the orders are based on the forecasts of customer orders rather than actual orders. Accordingly, we could be left with an excess of inventory on hand that has no available market due to
enhanced features on successor product lines. Our business and operating results could be adversely affected as a result of these increased costs.

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BECAUSE A SIGNIFICANT AND INCREASING PERCENTAGE OF OUR REVENUES COMES FROM SALES OUTSIDE THE U.S., WE ARE SUBJECT TO A NUMBER OF RISKS SPECIFIC TO THE INTERNATIONAL MARKETS IN
WHICH WE OPERATE.

Revenues from customers outside of the U. S. accounted for about 15.0% and 15.1% of our total revenues for the three months and six months ended
June 30, 2000, respectively and 3.2% and 12.3% of our total revenues for the three and six months ended June 30, 2001, respectively. As a part of our strategy, we intend to expand our
sales in international markets. Sales to international markets have the following material risks:



We
also utilize product development and other resources in order to meet regulatory and technical requirements of countries into which we sell our products. We depend on sales of our
products in these markets to offset the costs associated with developing products for these markets. If we are unable to generate sufficient sales to offset these expenses, our profitability will
suffer.

We
can give no assurance that non-U.S. markets for our products will continue to develop or develop at the rate we expect. Any failure of these markets to develop, or our
failure to increase sales to customers outside of the U.S., could harm our results of operations and the price of our Common Stock.

THE ABILITY OF NORTEL NETWORKS TO EXERCISE SIGNIFICANT INFLUENCE OVER OUR AFFAIRS COULD AFFECT OUR ABILITY TO IMPLEMENT SUCCESSFUL STRATEGIC AND OPERATIONAL INITIATIVES.

We were formed by means of a contribution agreement among Nortel Networks Corporation, its subsidiary Nortel Networks Inc., and us. Under this
agreement, we issued Nortel Networks Inc. 15,384,614 shares of our Common Stock. Prior to the closing of our IPO on October 4, 2000, Nortel Networks Inc. transferred 8,948,770
shares of our Common Stock, and a warrant for 51,230 shares of our Common Stock, to its parent, Nortel Networks Limited. Nortel Networks Limited sold 1,000,000 shares of our Common Stock in the IPO
and on December 28, 2000, Nortel Networks Inc. reacquired 7,948,770 shares of our Common Stock, and the warrant for 51,230 shares of our Common Stock, from Nortel Networks Limited.
Accordingly, Nortel Networks Inc. owns approximately 46%, or 14,435,845 shares, of our Common Stock, including the 51,230 shares of our Common Stock that are issuable upon exercise of the
warrant described above. Mr. Thomas M. Manley, appointed by Nortel Networks to our board of directors, is an executive of Nortel Networks. Although Nortel Networks announced in June 2001
its intent to divest its interests in Elastic Networks, because of Nortel Networks' current level of ownership of our Common Stock, and because of its board representation, Nortel Networks continues
to have the ability to exercise significant control over our affairs. There also may be conflicts of interest between Nortel Networks and us with respect to acquisitions, financings and other
corporate opportunities. Nortel Networks' ability to exercise significant control could have the effect of delaying

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or preventing a change in control of Elastic Networks and other strategic and operational initiatives, which could harm our business and the price of our Common Stock. In addition, because of its
current level of ownership of our Common Stock, Nortel Networks' stated initiative of divesting its interests in Elastic Networks could have a negative effect on the price of our Common Stock.

AN INTERRUPTION OR DISSOLUTION OF ANY ONE OF OUR RELATIONSHIPS WITH NORTEL NETWORKS COULD SIGNIFICANTLY HARM OUR BUSINESS AND FINANCIAL CONDITION.

We have entered into various agreements and relationships with Nortel Networks, including a distribution arrangement under which they have agreed to market and
distribute our products. We cannot predict whether Nortel Networks will continue to market and distribute our products or perform its other obligations under this or our other agreements.

IF WE FAIL TO PROTECT OUR INTELLECTUAL PROPERTY, OR IF OTHERS USE OUR INTELLECTUAL PROPERTY WITHOUT OUR PERMISSION, OUR COMPETITIVE POSITION MAY SUFFER.

Our ability to compete and be successful is based, in part, on our intellectual property. We rely on a combination of copyright, trademark, patent and trade
secret laws and contractual restrictions to establish and protect our technology and other intellectual property. We require employees and consultants and, when possible, suppliers, manufacturers and
distributors, to sign confidentiality agreements. However, we cannot assure you that our steps will be sufficient to prevent misappropriation of our technology and other intellectual property, or that
our competitors will not independently develop technologies or other intellectual property that are substantially equivalent or superior to ours. In addition, the laws of many countries do not protect
intellectual property to the same extent as the laws of the U.S. If our intellectual property rights are not protected, our business may suffer. For instance, an opposition to our registration of the
trademark "YesWare" was filed on June 12, 2000. We are currently assessing this opposition to determine the effect, if any, that this opposition may have if it is successful. If the opposition
succeeds, we will not be able to register this trademark and may be required to rename our YesWare product or license the trademark from the opposing party. If we have to bring a lawsuit against
another entity that infringes or misappropriates any of our intellectual property, we would likely have to divert significant resources, both financial and human, in prosecuting the lawsuit. We own
U.S. patent number 5,912,895, titled "Information Network Access Apparatus and Methods for Communicating Information Packets via Telephone Lines." This patent was issued on June 15, 1999 and
expires on May 1, 2016. We also have exclusive and non-exclusive licenses from Nortel Networks to other technologies that we use in our business. However, our rights to our patent
and to all of these licensed technologies are subject to various licenses that Nortel Networks, as the original owner, granted to other companies prior to May 12, 1999. Therefore, we cannot
assure you that our rights to these technologies will allow us to prevent these companies and their licensees from using these technologies.

In
addition, we have granted back to Nortel Networks licenses to these technologies and to all improvements that we may acquire or make to these technologies. We have also granted
Nortel Networks a license to any patents that we own, acquire, or result from our filing applications or from obtaining a license, during any period that Nortel Networks owns more than 50% of our
voting securities. Although these licenses are subject to Nortel Networks' obligation not to compete with us with respect to EtherLoop based products through May 12, 2002, there will be no
contractual restrictions on Nortel Networks' ability to engage in competitive activities with respect to EtherLoop based products after that date.

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Also, from time to time, we may desire or be required to obtain or renew licenses from other parties in order to further develop and market commercially viable products and for other
business purposes. There can be no assurance that the necessary licenses will be available upon acceptable terms, if at all. Our failure to obtain these licenses, or to protect and prevent the
misappropriation of our intellectual property, could significantly harm our competitive position.

DUE TO THE INTEGRATION OF OUR INTELLECTUAL PROPERTY WITH THIRD-PARTY TECHNOLOGIES IN OUR PRODUCT OFFERINGS, WE MAY BE SUBJECT TO INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS THAT
WOULD BE COSTLY TO DEFEND AND COULD HARM OUR BUSINESS AND ABILITY TO COMPETE.

Because our products integrate our intellectual property and third party technologies, we may be subject to the risk of adverse claims and litigation alleging
that our products, technologies and other intellectual property, as well as those of our licensors, infringe the intellectual property rights of others. Any of these claims could require us to pay
damages or settlement amounts and could require us to develop non-infringing intellectual property or acquire licenses to the intellectual property that is the subject of asserted
infringement claims. This could result in product delays or increased costs, either of which could harm our ability to compete and our profitability. In addition, the cost of defending any litigation
and resulting distraction of our management resources could harm our ability to generate and implement successful business strategies.

WE BELIEVE THAT EXPANSION OF OUR BUSINESS WILL BE REQUIRED FOR OUR COMPANY TO SUCCEED, AND IF WE FAIL TO MANAGE THIS EXPANSION EFFECTIVELY, OUR BUSINESS AND STOCK PRICE WILL
SUFFER.

We have rapidly and significantly expanded our operations since 1998. We believe that further expansion will be required to address potential growth in our
client base and market opportunities in order for us to be successful. From May 13, 1999 to July 25, 2001, we had a net increase in the number of employees from 58 to 109. To manage the
expected growth of our operations, we will be required to:



If
we are not able to manage our growth and its related costs effectively, it will be difficult to support our future operations.

WE MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE, WHICH COULD ADVERSELY AFFECT OUR STOCKHOLDERS; IF WE ARE UNABLE TO SECURE ADEQUATE FUNDS ON TERMS ACCEPTABLE TO US, WE
MAY BE UNABLE TO EXECUTE OUR BUSINESS PLAN.

If our existing cash balances and cash flows from operations are not sufficient to meet our liquidity needs, we will need to raise additional funds. If
additional funds are raised through the issuance of equity securities, the percentage ownership of pre-existing stockholders will be reduced. If additional funds are raised through the
issuance of debt or preferred equity securities, these securities would have rights, preferences and privileges senior to those of the Common Stock. Furthermore, the terms of any debt could impose
restrictions on our operations. If adequate funds are not available on acceptable terms, or are not available at all, we may not be able to take advantage of market opportunities, develop new products
or otherwise respond to competitive pressures.

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DUE TO A HIGH LEVEL OF STOCK OWNERSHIP, MANAGEMENT AND SOME OF OUR STOCKHOLDERS CAN EXERCISE SIGNIFICANT INFLUENCE OVER OUR BUSINESS AFFAIRS, WHICH COULD NEGATIVELY IMPACT OUR
OTHER STOCKHOLDERS' POTENTIAL RETURN ON INVESTMENT.

Our executive officers, directors and 5% or greater stockholders, and their affiliates, currently own an aggregate of approximately 66% of our outstanding
common stock. These stockholders, if acting together, could significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers
or other business combinations. This concentration of ownership may have the effect of delaying, deterring or preventing a change in control of Elastic Networks, which could prevent our stockholders
from receiving a premium for their Common Stock as part of any merger or other business combination.

OUR CERTIFICATE OF INCORPORATION, OUR BYLAWS AND DELAWARE LAW CONTAIN PROVISIONS THAT COULD DELAY OR PREVENT A CHANGE IN CONTROL.

Our certificate of incorporation and bylaws provide for a classified board of directors and restrict our stockholders from acting without a meeting. These
provisions may make some corporate actions more difficult and might delay or prevent a change in control. Further, our board of directors has the ability to issue up to 25.0 million shares of
preferred stock with certain rights, preferences, privileges and restrictions, including voting rights, that could be senior to those of our Common Stock. New preferred stock might also be used to
make acquiring control of us more difficult. We will also indemnify officers
and directors against losses incurred in legal proceedings to the broadest extent permitted by Delaware law.

OUR MARKET IS SUBJECT TO RAPID CHANGES IN INDUSTRY STANDARDS AND TECHNOLOGY, AND IF WE FAIL TO CONTINUALLY MAKE NEW PRODUCT INTRODUCTIONS AND ENHANCEMENTS, OUR ABILITY TO
EFFECTIVELY COMPETE WILL SUFFER.

The market for high-speed access products is characterized by rapid technological developments, frequent enhancements to existing products, new
product introductions, changes in end user requirements and evolving industry standards. Any technological advancements, whether in DSL or otherwise, or product introductions that provide faster
access, greater reliability, increased cost-effectiveness or other advantages over our technology, could render our product line obsolete. We cannot assure you that we will be able to
respond quickly and effectively to any of these changes or challenges. Moreover, in order to respond quickly and effectively to all of these changes and challenges, we must continually make
investments in the development of new technologies and the further advancement of our current technologies. However, the nature and quantity of these investments cannot be definitively predicted, and
we may not have sufficient resources to make these investments.

Even
if we are able to make the necessary investments, the development of new or enhanced products or technologies is a complex and uncertain process requiring the accurate
anticipation of technological and market trends. We may experience design, manufacturing, marketing and other difficulties that could delay or prevent our development, introduction or marketing of new
or enhanced products or technologies. The introduction of new or enhanced products or technologies also requires that we manage the transition from older products or technologies in order to minimize
disruption in customer ordering patterns and ensure that adequate supplies of new products can be delivered to meet anticipated customer demand. We may not be able to successfully develop or
introduce, or manage the transition to, these new products. Furthermore, despite testing by our contract manufacturers and us, any of these new or enhanced products or technologies may contain
undetected or unresolved errors when they are first introduced or as new versions are released.

To
the extent that we are unable to effectively address these technological changes and challenges, our business, financial condition, results of operations and the price of our
Common Stock could be harmed.

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OUR MARKET IS HIGHLY COMPETITIVE AND OUR PRODUCTS, TECHNOLOGY AND BUSINESS MAY NOT BE ABLE TO COMPETE EFFECTIVELY WITH OTHER PRODUCTS OR TECHNOLOGIES.

The market for high-speed access products is highly competitive, and we expect that it will become increasingly competitive in the future. In
addition to facing competition from providers of DSL based products, our products currently compete with products using other technologies. Our most direct competitors include Alcatel
USA, Inc., Cisco Systems, Inc., Copper Mountain Networks, Inc., Lucent Technologies Inc., Nokia Corporation and Tut Systems, Inc. In addition, due to the rapidly
evolving nature of the market in which we compete, additional competitors, including other large telecommunications equipment manufacturers, as well as smaller companies, may enter our markets and
further intensify competition. These and our other competitors may foresee the course of market developments more accurately than we do.

In
addition, many of our current and potential competitors have significantly greater sales and marketing, technical, manufacturing, and financial and other resources than we do, such
as AT&T and AOL/Time Warner in the cable broadband market. The products and technologies offered by these competitors may provide faster access and higher reliability than ours, and prove more
cost-effective for some end users.

Commercial
acceptance of any one of these competing solutions could decrease the demand for our products, result in our loss of market share and reduce average selling prices and the
profit margins associated with our products.

OUR COMPANY, OUR PRODUCTS AND OUR CUSTOMERS ARE SUBJECT TO GOVERNMENT REGULATIONS, AND CHANGES IN CURRENT OR FUTURE LAWS OR REGULATIONS THAT COULD NEGATIVELY IMPACT OUR
PRODUCTS, OUR CUSTOMERS OR US COULD HARM OUR BUSINESS.

The Federal Communications Commission ("FCC") regulates the telecommunications industry, including our company, our products and our customers. The adoption of
new FCC regulations affecting the broadband access industry, our customers or our products may harm our business. For example, FCC policies that affect the availability of data and Internet services
may impede our customers' penetration into certain markets or affect the prices they charge. In turn, this may reduce their orders for our products.

In
addition, international regulatory bodies are beginning to adopt regulations and standards for the communications industry. These regulations and standards may require us to make
engineering or functional changes to our products, or changes to our marketing and selling practices. Delays caused by changes in our products or practices undertaken to comply with state, national
and international regulatory requirements may result in order cancellations or postponements of product purchases by our customers, which could harm our sales and our reputation.

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Under the Company's current policies, it does not use interest rate derivatives, foreign currency exchange rate derivatives, commodity prices derivatives,
equity derivatives, or any other derivatives, for trading or any other purposes. As of June 30, 2001, no debt instruments of the Company were outstanding, and its investments in financial
instruments were limited to investing its excess cash in various investment-grade commercial paper, money market accounts, and debt instruments of the U.S. Treasury, government agencies, and
corporations with strong credit ratings, generally with original maturity dates from dates of purchase of three months or less. The Company's investments in such financial instruments are exposed to
financial market risk due to fluctuations in interest rates and foreign currency exchange rates.

At
June 30, 2001, the fair market value of the Company's investments in those of such financial instruments that were exposed to financial market risk due to fluctuations in
foreign currency exchange rates was not material. At June 30, 2001, the fair market value of the Company's investments in those of such financial instruments that were exposed to financial
market risk due to fluctuations in interest rates totaled, in the aggregate, $41.3 million. However, due to the short-term nature of its investment portfolio, the Company does not
expect that a sudden change in market interest rates would materially affect the future earnings, fair values, or cash flows of these interest-sensitive financial instruments. For example, a
hypothetical 100 basis point adverse move in interest rates, which represents the Company's expectation for a reasonably possible near-term change in such rates, would result in an annual
reduction in interest income and cash flow of approximately $413,000, which the company considers to be immaterial.

A
significant portion of the Company's revenues is derived from sales shipped internationally. Currently, all of the Company's sales shipped internationally are denominated in U.S.
dollars. If the value of the U.S. dollar increases relative to a particular foreign currency, the Company's products could become relatively more expensive, which could result in a reduction in the
Company's sales in a particular country.

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PART IIOTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS.

(d) Use of Proceeds.

During
the period commencing on September 28, 2000 (the effective date of the Company's Registration Statement on Form S-1, as amended (Registration
No. 333-40500)) and ended June 30, 2001, the Company used approximately $1.9 million of the IPO proceeds (net of expenses and commissions) to fund the expansion of its
business, approximately $36.4 million to fund its operating deficits and approximately $8.3 million for other working capital needs and general corporate purposes.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

On
May 9, 2001, we held our 2001 Annual Meeting of Stockholders (the "Annual Meeting"). At the Annual Meeting, the following matters were approved by the votes specified below:



ITEM 5.  OTHER INFORMATION.

Effective as of September 2001, Thomas H. Acker resigned as Vice President of Manufacturing Operations of the Company. Mr. Acker has agreed to
continue as an employee of the Company until September 2001, and during this period he will assist the Company in the management transition for the Operations area.

John
B. ("Jack") Terry, Special Technology Consultant for the Company, died in July 2001. Mr. Terry invented EtherLoop technology while serving as an assistant vice
president of Nortel Networks. The Company retained his services as a special technology consultant for the further development of its technology and products.

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

| | (a) Exhibits.                                                                                         
| | ------------------------------------------------------------------------------------------------------
| | (3)(i)                                                                                                
| | (ii)                                                                                                  
| | (4)                                                                                                   
| | (b) Reports on Form 8-K.                                                                              
| | No reports on Form 8-K were filed or were required to be filed during the quarter ended June 30, 2001.

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SIGNATURES

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

|                     |  | ELASTIC NETWORKS INC.
(Registrant)                                                                                                
|-------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------
|Date: August 9, 2001 |  | /s/ Guy D. GillGuy D. Gill
Chairman of the Board of Directors,
Chief Executive Officer and President
(principal executive officer)
|Date: August 9, 2001 |  | /s/ Kevin D. ElopKevin D. Elop
Chief Financial Officer, Secretary and
Treasurer
(principal financial and accounting officer)      

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