NETOPIA INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2005

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

For the transition period from to

Commission file number 0-28450

Netopia, Inc.

(Exact name of registrant as specified in its charter)

Delaware

94-3033136

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

6001 Shellmound Street, 4^th Floor

Emeryville, California 94608

(Address of principal executive offices, including Zip Code)

(510) 420-7400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ No ¨

As of May 6, 2005, there were 25,211,340 shares of the Registrant’s common stock outstanding.

NETOPIA, INC.

Form 10-Q

Table of Contents


		Page
PART I.	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements	1

	Condensed Consolidated Balance Sheets at March 31, 2005 and September 30, 2004	1

	Condensed Consolidated Statements of Operations for the three and six months ended March 31, 2005 and 2004	2

	Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2005 and 2004	3

	Notes to Condensed Consolidated Financial Statements	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32

Item 4.	Controls and Procedures	33

Item 4A.	Submission of Matters to a Vote of Security Holders	35

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	36

Item 6.	Exhibits and Reports on Form 8-K	38

Signatures		39

Certifications		40

PART I — FINANCIAL INFORMATION

Our Annual Report on Form 10-K for the fiscal year ended September 30, 2004 (the “2004 10-K”) amended our Annual Reports on Form 10-K previously filed for the fiscal years ended September 30, 2003 and September 30, 2002, and our previously filed reports on Form 10-Q for the fiscal quarters ended March 31, 2004 and December 31, 2003, to reflect the restatements of our consolidated financial statements for all such previously reported periods. This Form 10-Q should be read in conjunction with the 2004 10-K, in which we explain the restatements of our consolidated financial statements.

ITEM 1.

UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NETOPIA, INC.

Condensed Consolidated Balance Sheets


	March 31, 2005 (Unaudited)			September 30, 2004 (1)
	(in thousands)
Assets
Current assets:
Cash and cash equivalents	$	22,714		$	23,973
Trade accounts receivable, net of allowances for doubtful accounts of $148 and $111, respectively		15,245			17,812
Inventories, net		6,525			6,280
Prepaid expenses and other current assets		769			1,226

Total current assets		45,253			49,291

Furniture, fixtures and equipment, net		2,505			2,694
Acquired technology and other intangible assets, net		3,193			4,016
Goodwill		1,668			1,668
Long-term investments		1,032			1,032
Deposits and other assets		711			886

TOTAL ASSETS		54,362			59,587

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		10,449			9,827
Accrued compensation		1,908			2,582
Accrued liabilities		1,402			3,806
Deferred revenue		1,297			1,679
Current portion of borrowings under term loans		—			104
Other current liabilities		61			53

Total current liabilities		15,117			18,051
Long-term liabilities:
Other long-term liabilities		305			406

Total liabilities		15,422			18,457

Stockholders’ equity:
Common stock: $0.001 par value, 50,000,000 shares authorized; 25,202,344 and 24,717,503 shares issued and outstanding at March 31, 2005 and September 30, 2004, respectively		25			25
Additional paid-in capital		167,548			166,245
Other Comprehensive Income (loss)		(20	)		—
Accumulated deficit		(128,613	)		(125,140	)
Total stockholders’ equity		38,940			41,130

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	54,362		$	59,587

(1)	Derived from the audited consolidated balance sheet dated September 30, 2004 included in the 2004 10-K.

See accompanying notes to Condensed Consolidated Financial Statements.

Page 1

NETOPIA, INC.

Condensed Consolidated Statements of Operations

Unaudited


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004 (1)			2005			2004 (1)
	(in thousands, except per share amount)
REVENUES:
Broadband equipment	$	22,247		$	17,878		$	48,444		$	41,535
Broadband software and services		2,976			3,879			6,097			8,531

Total revenues		25,223			21,757			54,541			50,066

COST OF REVENUES:
Broadband equipment		16,307			12,573			36,252			29,023
Broadband software and services		384			231			650			439
Amortization of acquired technology		300			300			600			600

Total cost of revenues		16,991			13,104			37,502			30,062

GROSS PROFIT		8,232			8,653			17,039			20,004

OPERATING EXPENSES:
Research and development		3,403			4,057			6,609			8,008
Selling and marketing		4,582			5,037			9,667			10,063
General and administrative		2,029			1,172			4,224			2,407
Amortization of intangible assets		87			87			173			173
Restructuring costs		98			—			98			—

Total operating expenses		10,199			10,353			20,771			20,651

OPERATING LOSS		(1,967	)		(1,700	)		(3,732	)		(647	)
Other income (loss), net		155			77			303			245
Provision for income taxes		20			(11	)		44			46

NET LOSS	$	(1,832	)	$	(1,612	)	$	(3,473	)	$	(448	)

Per share data, net loss:
Basic and diluted net loss per share	$	(0.07	)	$	(0.07	)	$	(0.14	)	$	(0.02	)
Shares used in the computation of net loss per share
Basic and diluted		25,038			23,536			24,892			22,882

(1)	Derived from the 2004 10-K.

See accompanying notes to Condensed Consolidated Financial Statements.

Page 2

NETOPIA, INC.

Condensed Consolidated Statements of Cash Flows

Unaudited


	Six Months Ended March 31,
	2005			2004
	(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(3,473	)	$	(448	)
Reconciliation of net loss to net cash used in operating activities:
Depreciation and amortization		1,839			2,338
Changes in allowance for doubtful accounts		16			(113	)
(Capitalization)/Write-off of capitalized software development costs		—			(18	)
Cumulative translation adjustment		(20	)		—
Restructuring costs		(443	)		—
Changes in operating assets and liabilities:
Trade accounts receivable		2,551			1,661
Inventories		(245	)		(6,248	)
Prepaid & other current assets		457			19
Deposits and other assets		175			37
Accounts payable and accrued liabilities		(48	)		492
Deferred revenue		(382	)		(125	)
Other liabilities		(2,058	)		(186	)

Net cash used in operating activities		(1,631	)		(2,591	)

Cash flow from investing activities:
Purchase of furniture, fixtures and equipment		(827	)		(856	)
Acquisition of business		—			(146	)
Acquisition of intangibles		—			(300	)

Net cash used in investing activities		(827	)		(1,302	)

Cash flow from financing activities:
Repayment of term loans		(104	)		(126	)
Proceeds from the issuance of common stock		1,303			7,739

Net cash provided by financing activities		1,199			7,613

Net increase (decrease) in cash and cash equivalents		(1,259	)		3,720
Cash and cash equivalents, beginning of period		23,973			22,208

Cash and cash equivalents, end of period	$	22,714		$	25,928

Supplemental disclosures of cash flow activities:
Income taxes paid	$	—		$	9

Interest paid	$	27		$	58

Issuance of common stock for acquisition of business	$	—		$	1,249

See accompanying notes to Condensed Consolidated Financial Statements.

Page 3

NETOPIA, INC.

Notes to Condensed Consolidated Financial Statements

(1)

The Company

Netopia, Inc. (“Netopia”, the “Company” or “we”) develops and markets broadband equipment, remote management software and broadband services.

Our broadband equipment includes a family of telecommunications carrier-class broadband equipment, including modems, routers and gateways (collectively referred to as “gateways”), and related accessories. Our gateways provide a link between telecommunication carrier’s lines and residential and distributed business networks. The gateways provide functionality, including converting electronic and analog signals to digital communication, network routing, and wired and wireless networked connectivity for simultaneous voice, video, data and other applications.

Our products provide broadband solutions to our customers, the largest of which are telecommunication carriers and Internet Service Providers, for the delivery of broadband services to their residential and business-class customers. Our solutions enable carriers and broadband service providers to (i) deliver our feature-rich gateways to their customers, (ii) utilize our software that allows remote management of equipment located at their customers’ premises in order to reduce customer support costs, and (iii) provide value added services, including combined voice, video and data services.

Our remote management software products enable remote control, monitoring and service provisioning of broadband equipment and the personal computers with which they interact. Our software solutions are designed to meet the requirements of a full range of users: individual-to-individual, carrier-to-customer, and help desk-to-users.

Our broadband services include wireless hot spots, web site and store hosting, merchant services and parental controls.

(2)

Pro Forma Stock Compensation Expense

We maintain stock option plans under which we may grant incentive stock options and non-statutory stock options. Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans based on the fair market value of options granted. We account for stock based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Because the grant price equals the market price on the date of grant for all options we issued, we did not recognize compensation expense for stock options granted to our employees and directors. In accordance with SFAS No. 123, we recognize as an expense, the fair value of options and other equity instruments granted to non-employees other than to our directors. We have not issued any stock options to non-employees since fiscal year 2001 other than to our directors. In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, Accounting for Stock Based Compensation – Transition and Disclosure, which amends SFAS No. 123. SFAS No. 148 requires more prominent and frequent disclosures about the effects of stock-based compensation. We will continue to account for our stock based compensation according to the provisions of APB No. 25, through the end of the fiscal year ending September 30, 2005. SFAS No. 148 requires the disclosure of pro forma net income and earnings per share. Under SFAS No. 148, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.

Page 4

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


Three Months Ended March 31,	2005		2004
Expected life (in years)	3.23		3.29
Expected volatility	355	%	282	%
Risk-free interest rate	3.96		2.80
Expected dividend yield	—		—

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


Three Months Ended March 31,	2005		2004
Expected life (in years)	2		2
Expected volatility	230	%	133	%
Risk-free interest rate	3.80		3.15
Expected dividend yield	—		—

The following table illustrates the effect on our net loss and net loss per share if we had recorded compensation costs based on the estimated grant date fair value defined by SFAS No. 123 for all granted stock-based awards:


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
	(in thousands, except per share data)
Net loss, as reported	$	(1,832	)	$	(1,612	)	$	(3,473	)	$	(448	)
Option fair value amortization		1,211			1,612			2,583			3,263
Net loss, pro forma	$	(3,043	)	$	(3,224	)	$	(6,056	)	$	(3,711	)

Basic and diluted net loss per share – as reported	$	(0.07	)	$	(0.07	)	$	(0.14	)	$	(0.02	)
Basic and diluted net loss per share – Pro Forma	$	(0.12	)	$	(0.14	)	$	(0.24	)	$	(0.16	)

The Black-Scholes Single Option weighted average fair value of employee stock options granted during the three months ended March 31, 2005 and 2004 was $3.39 and $13.81, respectively. The Black-Scholes Single Option weighted average fair value of employee stock options granted during the six months ended March 31, 2005 and 2004 was $2.94 and $10.68, respectively.

(3)

Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements includes the accounts of Netopia and its subsidiaries. All material intercompany balances and transactions have been eliminated. The interim financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of the results for the periods presented. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. The Condensed Consolidated Balance Sheet as of September 30, 2004 has been derived from the audited financial statements at that date. However, it does not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements.

The accompanying financial statements should be read in conjunction with the audited financial statements of Netopia for the fiscal year ended September 30, 2004, included in our 2004 10-K.

Page 5

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

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

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


	March 31, 2005		September 30, 2004
	(in thousands)
Raw materials	$	1,265	$	1,595
Work in process		418		448
Finished goods		4,842		4,237

Inventories	$	6,525	$	6,280

(4)

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), which replaces SFAS No. 123 Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 no longer will be an alternative to financial statement recognition. We are required to adopt SFAS No. 123R in the first quarter of fiscal year 2006, beginning October 1, 2005. Under SFAS No. 123R, we must determine the appropriate fair value model to be used for valuing share-based payments and the amortization method for compensation cost. We are evaluating the requirements of SFAS No. 123R and expect that the adoption of SFAS No. 123R will have a material impact on our consolidated results of operations and earnings per share. We have not yet determined the effect of adopting SFAS No. 123R, and we have not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS No. 123.

In March 2004, the FASB ratified the recognition and measurement guidance and certain disclosure requirements for impaired securities as described in Emerging Issues Task Force (EITF) Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF Issue No. 03-1 provides new guidance for determining and recording impairment for both debt and equity securities. It also requires additional disclosure for declines in investments that are deemed to be temporary under the standard. In September 2004, the FASB approved the issuance of a FASB Staff Position to delay certain measurement and recognition guidance contained in EITF Issue No. 03-1. We do not expect that the adoption of the recognition and measurement provisions will have a material impact on our consolidated balance sheet or statement of operations. The disclosure requirements are effective for fiscal years ending after June 15, 2004, and are required only for annual periods.

(5)

Goodwill and Other Intangible Assets

The Company’s intangible assets at March 31, 2005 consist of goodwill acquired in connection with the acquisitions of JadeSail and WebOrder, and other intangible assets acquired in connection with the acquisitions of JadeSail and Cayman.

Page 6

Goodwill as of March 31, 2005 and September 30, 2004 was maintained in our broadband software and services segment as follows:


	Acquisition date	Goodwill
		(in thousands)
JadeSail	Oct-03	$	1,149
WebOrder	Mar-00		519

Total Goodwill		$	1,668

Acquired intangible assets are amortized over their estimated useful lives. The carrying amounts and amortization expense by segment are in the table below:


	Acquisition date	Balance at September 30, 2004		Amortization expense for the Six Months Ended March 31, 2005			Balance at March 31, 2005
	(in thousands)
Broadband equipment:
Acquired technology	Oct-03	$	197	$	(24	)	$	173
Acquired technology	Oct-01		3,234		(576	)		2,658
Sales channel relationships	Oct-01		345		(172	)		173
Subtotal			3,776		(772	)		3,004
Broadband software and services:
Marketing license	Jan-03		240		(51	)		189
Subtotal			240		(51	)		189

Total Other Intangibles		$	4,016	$	(823	)	$	3,193

(6)

Per Share Calculations

Basic net loss per share is calculated from the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is calculated from the weighted average number of shares of common stock outstanding during the period plus potential dilutive shares from options outstanding using the treasury stock method. All options outstanding have been excluded from the computation of the diluted loss per share for the three and six months ended March 31, 2005 and 2004, because their effect on the loss per share was anti-dilutive. The following table details the per share calculations:


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
	(in thousands; except per share amounts)
Calculation of basic and diluted net loss per share:
Net loss	$	(1,832	)	$	(1,612	)	$	(3,473	)	$	(448	)
Shares used in the computation of net loss per share		25,038			23,536			24,892			22,882

Basic and diluted net loss per share	$	(0.07	)	$	(0.07	)	$	(0.14	)	$	(0.02	)

For the three months ended March 31, 2005 and 2004, the computation of diluted loss per share excluded options to purchase common stock totaling 474,963 and 3,567,594 shares, respectively.

For the six months ended March 31, 2005 and 2004, the computation of diluted loss per share excluded options to purchase common stock totaling 371,131 and 3,695,932 shares, respectively.

Page 7

(7)

Segment, Geographic and Significant Customer Information

Segment Information: The Company operates in two segments, broadband equipment and broadband software and services. The Company evaluates performance based on net revenues and gross profits from operations of these two segments, which is detailed for the three and six months ended March 31, 2005 and 2004 as follows:


	2005									2004
Three months ended March 31,	Broadband equipment			Broadband Software & Services			Total			Broadband equipment			Broadband Software & Services			Total
	($ in thousands)
Revenue	$	22,247		$	2,976		$	25,223		$	17,878		$	3,879		$	21,757
Cost of revenues		16,307			384			16,691			12,573			231			12,804
Amortization of acquired technology		288			12			300			288			12			300

Gross profit		5,652			2,580			8,232			5,017			3,636			8,653
Gross margin		25	%		87	%		33	%		28	%		94	%		40	%
Unallocated operating expenses								10,199									10,353

Operating loss							$	(1,967	)							$	(1,700	)


	2005									2004
Six months ended March 31,	Broadband equipment			Broadband Software & Services			Total			Broadband equipment			Broadband Software & Services			Total
	($ in thousands)
Revenue	$	48,444		$	6,097		$	54,541		$	41,535		$	8,531		$	50,066
Cost of revenues		36,252			650			36,902			29,023			439			29,462
Amortization of acquired technology		576			24			600			576			24			600

Gross profit		11,616			5,423			17,039			11,936			8,068			20,004
Gross margin		24	%		89	%		31	%		29	%		95	%		40	%
Unallocated operating expenses								20,771									20,651

Operating loss							$	(3,732	)							$	(647	)

Geographic Information: The Company sells its products and provides services worldwide through our own sales force, independent distributors and value-added resellers. The Company operates primarily in two regions: the United States and Europe. Revenues outside of the United States are primarily export sales denominated in United States Dollars or Euros. Revenues by geographic region for the three and six months ended March 31, 2005 and 2004 follows:


	Three months ended March 31,								Six months ended March 31,
	2005				2004				2005				2004
	( in thousands)
Europe	$	8,288	33	%	$	7,947	37	%	$	17,409	32	%	$	19,995	40	%
Canada		204	1	%		188	1	%		521	1	%		359	1	%
Asia Pacific and other		510	2	%		604	3	%		1,099	2	%		1,289	3	%

Subtotal international revenue		9,002	36	%		8,739	40	%		19,029	35	%		21,643	43	%
United States		16,221	64	%		13,018	60	%		35,512	65	%		28,852	57	%

Total revenues	$	25,223	100	%	$	21,757	100	%	$	54,541	100	%	$	50,495	100	%

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

Customer Information: The Company sells its products to incumbent local exchange carriers (“ILECs”), competitive local exchange carriers (“CLECs”), distributors, Internet Service Providers

Page 8

(“ISPs”), and end-users. Revenues from customers that accounted for 10% or more of revenue for one or more of the three and six months ended March 31, 2005 and 2004 follows:


	Three months ended March 31,								Six Months Ended March 31,
	2005				2004				2005				2004
	(in thousands)
BellSouth	$	3,978	16	%	$	1,356	6	%	$	11,217	21	%	$	2,204	4	%
Swisscom AG		3,634	14	%		3,431	16	%		7,846	14	%		11,693	23	%
eircom Ltd.		2,867	11	%		865	4	%		5,314	10	%		2,195	4	%
SBC Communications		2,193	9	%		2,350	11	%		5,112	9	%		4,967	10	%

For the three months ended March 31, 2005 and 2004, there were three customers and two customers, respectively, that each individually represented at least 10% of revenues and in the aggregate, accounted for 41% and 27%, respectively, of total revenues. For the six months ended March 31, 2005 and 2004, there were three customers and two customers, respectively, that each individually represented at least 10% of revenues and in the aggregate, accounted for 45% and 33%, respectively, of total revenues.

The following table sets forth the accounts receivable balance for customers with balances at March 31, 2005 and 2004, which were at least 10% of the total accounts receivable balance at one or more period end:


March 31,	2005			2004
	(in thousands)
Swisscom AG	2,761	18	%	2,962	20	%
eircom Ltd.	2,704	18	%	1,044	7	%
BellSouth	1,924	13	%	933	6	%

(8)

Investment in Non-Public Entities

At March 31, 2005 the Company owned 1,850,000 shares of MegaPath Networks, Inc., which represents approximately a 1.8% interest in this private company. MegaPath offers high-speed broadband access to small and medium size businesses. The carrying value of our investment was $1.0 million at March 31, 2005 and was accounted for using the cost method.

During the three months ended March 31, 2005 and 2004, MegaPath purchased $4,000 and $340,000, respectively, of the Company’s products. During the six months ended March 31, 2005 and 2004, MegaPath purchased $16,000 and $625,000, respectively, of the Company’s products. During the six months ended March 31, 2005, MegaPath has purchased the Company’s products mostly through an independent distributor, and not directly from the Company.

At March 31, 2005 and 2004, MegaPath’s accounts receivable with the Company was $1,700 and $183,000, respectively.

(9)

Restructuring Cost

During the three months ended March 31, 2005, the Company recorded a restructuring charge of $98,000, primarily consisting of employee termination costs, wind down costs associated with the closure of a sales office in the Netherlands and additional wind down costs associated with the prior closure of the Germany office in the quarter ended September 30, 2004.

Page 9

Detail of the remaining liabilities relating to restructuring activities as of March 31, 2005 is as follows:


	Severance			Facilities			Totals
	(in thousands)
Accrued liabilities at September 30, 2004	$	473		$	27		$	500
Restructuring charges		—			—			—
Amount paid		(423	)		(16	)		(439	)
Non-cash charges		—			—			—

Accrued liabilities at December 31, 2004	$	50		$	11		$	61

Restructuring charges		52			46			98
Amount paid		(64	)		(37	)		(101	)
Non-cash charges		—			—			—

Accrued liabilities at March 31, 2005	$	38		$	20		$	58

The $58,000 accrual as of March 31, 2005 is comprised of severance and facilities related charges estimated to be paid during the remainder of fiscal year 2005.

(10)

Commitments and Contingencies

As of March 31, 2005, we had commitments that consisted of facilities and equipment under operating lease agreements and purchase commitments primarily for inventory. Our purchase commitments relate to component inventory procured by our contract manufacturers on our behalf based on our production orders. We are obligated to purchase such component inventory unless orders are cancelled within agreed upon lead times. As of March 31, 2005 purchase commitments totaled $19.5 million. The following table summarizes future minimum lease payments:


	Fiscal Years
	2005	2006	2007	2008	2009	Thereafter	Totals
	(In thousands)
Property lease obligations	634	1,107	1,139	809	149	76	3,914

(11)

Warranty Liability

Warranty liability is recorded as a component of accrued liabilities on the Company’s Condensed Consolidated Balance Sheet. For the Company’s broadband equipment products, the Company generally provides a one-year warranty to domestic purchasers and a two-year warranty to international purchasers. The Company generally does not offer a warranty on its broadband software and services products. We analyze our estimated warranty liability based upon historic return rates and record adjustments to our warranty liability as necessary.

The following table summarizes the changes in accrued warranty during the three and six months ended March 31, 2005 and 2004 related to our product warranty liability, included in accrued liabilities in our consolidated condensed balance sheets.


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
	(In thousands)
Beginning balance	$	(170	)	$	(193	)	$	(140	)	$	(200	)
Cost of warranty replacements		63			62			129			258
Provision		(31	)		36			(127	)		(153	)

Ending balance	$	(138	)	$	(95	)	$	(138	)	$	(95	)

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(12)

Credit Facility

In December 2004, the Company amended its credit facility agreement with Silicon Valley Bank, which resulted in an extension and amendments to the tangible net worth covenant. The new covenant requires that the Company must maintain a minimum tangible net worth of $27 million plus 50% of the Company’s net income in each fiscal quarter commencing with the first fiscal quarter ended December 31, 2004. For the fiscal quarter ended March 31, 2005, the tangible net worth required by this amendment is $23 million plus 50% of the Company’s net income. For fiscal quarter ending June 30, 2005, the tangible net worth requirement is $19 million plus 50% of the Company’s net income. In July 2005, the tangible net worth covenant will be reset based on mutually agreed terms and shall continue effective thereafter, as well as amending Collection of Accounts, Filing of the Transaction Reports, Limits on the Revolving Loans, Collateral Monitoring Fee and Interest Rate on the Loans as noted below. The Company must also maintain an adjusted quick ratio, as defined as the ratio of (i) the Company’s unrestricted cash maintained at Silicon Valley Bank plus cash equivalents maintained at Silicon Valley Bank plus receivables and investments made on behalf of the Company through Silicon Valley Bank’s Investment Product Services Division (ISP Division) to (ii) the Company’s current liabilities plus the outstanding principal amount of any obligations less deferred revenues, of not less than 1.25 to 1 from April 30, 2003, and each month ending thereafter.

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

The borrowing availability under the amended credit facility is based on the lower of $15 million or certain eligible receivables plus certain eligible inventories. As of March 31, 2005, the borrowing availability was approximately $6.9 million, and we had no outstanding borrowings.

(13)

Other Income (Loss), Net

Other income (loss), net primarily consisted of interest income earned on cash and cash equivalents, interest expense related to the credit facility and term loans, and gains and losses on foreign currency transactions. The following table summarizes other income (loss), net:


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
	(in thousands)
Interest income	$	109		$	50		$	201		$	92
Interest expense		(10	)		(34	)		(13	)		(63	)
Other income		56			61			115			216

Total other income (loss), net	$	155		$	77		$	303		$	245

(14)

Financial Instruments

We use fair value derivative instruments to hedge exposed currency risk arising from fluctuations in foreign exchange rates on our Euro-denominated accounts receivables. These derivative instruments are intended to mitigate the risk of significant balance sheet fluctuations caused by foreign exchange rate movements. Gains and losses on the derivatives were largely offset by gains or losses resulting from the remeasurement of the foreign currency denominated assets being hedged. We recognize gains and losses resulting from changes in the fair value of derivative instruments in Other Income (Loss), Net.

Page 11

As of March 31, 2005, the Company had entered into a foreign currency forward contract that had the effect of fixing the exchange rate on Euro 900,000 at $1.3117 through the settlement date on April 29, 2005.

(15)

Comprehensive Loss

The table below presents the comprehensive loss for the three and six months ended March 31, 2005 and includes the translation of our foreign subsidiaries into our reporting currency, the United States Dollar:


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
	(in thousands)
Net loss	$	(1,832	)	$	(1,612	)	$	(3,473	)	$	(448	)
Foreign currency translation adjustment		7			(71	)		(20	)		(71	)

Total comprehensive loss	$	(1,825	)	$	(1,683	)	$	(3,493	)	$	(519	)

(16)

Litigation

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

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

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

Page 12

complaint. We believe that we have strong defenses to the claims asserted in the complaints as initially filed. We intend to defend the cases vigorously.

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

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

In January 2005, we were notified by the Occupational Health and Safety Administration (OSHA) that Netopia was named in an administrative complaint filed by two former employees alleging violations of Section 806 of the Corporate and Criminal Fraud Accountability Act of 2002, 18 U.S.C. § 1514A, also known as the Sarbanes-Oxley Act. The former employees allege the Company terminated them in retaliation for their participation in the Internal Accounting Review conducted by the audit committee. We filed a response to the complaint on January 21, 2005 with OSHA. (The Internal Accounting Review is described in greater detail in the 2004 10-K in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.) OSHA is investigating to determine whether it will pursue this matter. We believe that we have strong defenses and intend to defend the complaint vigorously.

In February 2005, we were served with a complaint filed in the County Court of Dallas County, Texas by the two former employees who filed the OSHA administrative complaint described above. The complaint names the Company and Alan Lefkof as defendants, and asserts claims for defamation and breach of contract. We have removed the case to the United States District Court for the Northern District of Texas, Dallas Division. We believe that we have strong defenses to the claims asserted in the complaint. We intend to defend the case vigorously.

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

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

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PART I — FINANCIAL INFORMATION

ITEM 2.

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

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

Company Overview

We develop and market broadband equipment, remote management software and broadband services.

Our products provide broadband solutions to our customers, the largest of which are telecommunication carriers and Internet Service Providers, for the delivery of broadband services to their residential and business-class customers. Our solutions enable carriers and broadband service providers to (i) deliver our feature-rich broadband modems, routers and gateways to their customers, (ii) utilize our software that allows remote management of equipment located at their customers’ premises, in order to reduce customer support costs and (iii) provide value added services, including combined voice, video and data services.

Our broadband services include wireless hot spots, web site and store hosting, merchant services and parental controls.

Broadband Equipment. We offer a family of telecommunications carrier-class broadband equipment, including modems, routers and gateways (collectively referred to as “gateways”), and related accessories. Our gateways provide a critical link between telecommunication carrier’s lines and residential and distributed business networks. The gateway provides critical functionality, including converting electronic and analog signals to digital communication, network routing, and wired and wireless networked connectivity for simultaneous voice, video, data and other applications.

Our gateways connect to carrier lines and enable the transport of broadband, high-speed data over carrier networks including the local copper wires (often referred to as “loop”) and new deployments of fiber-optic networks.

Our family of gateways serves many network interfaces including digital subscriber line (“DSL”), Ethernet and T1. For the users, our gateways support both wireless (often referred to as Wi-Fi) and Ethernet network connectivity.

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As carrier-class gateways, our products are designed to deliver high performance, excellent reliability, scalability, and affordability, and to be a platform from which carrier and service providers can offer their customers additional services and applications, especially voice, video and data.

We believe our gateways are differentiated by:

•

Carrier-class high-quality and high-performance;

•

Comprehensive interoperability with leading carrier central office DSL equipment;

•

High-performing, high quality common firmware deployed across our broadband gateways;

•

Performance enhancing wireless technology branded as 3-D Reach^{^™} technology, which we believe gives our Wi-Fi products leading wireless range and coverage; and

•

Our quality of service enhancing virtual gateway technology, branded as VGx technology, which provides gateway service segmentation for high quality voice, video and data services; and parental controls technology that enables the blocking of adult content and supervision of Internet access.

Most of our revenues are generated from sales of our DSL gateways to major telecommunication carriers, who in-turn include our gateways as part of their service offering to their customers.

Our gateways are installed by the customers of carriers and broadband service providers to obtain high-speed, always-on access to the Internet. Our DSL and other broadband gateways are often bundled with virtual private networking (“VPN”) capabilities that allow secure communications over the Internet, firewall protection, parental controls, hot spot access, Web content filtering, and combined voice, video, data and other services.

During the three months ended March 31, 2005 and 2004, revenue from the sale of our broadband equipment accounted for 88% and 82%, respectively, of our total revenues. During the six months ended March 31, 2005 and 2004, revenue from the sale of our broadband equipment accounted for 89% and 83%, respectively, of our total revenues. When reading our condensed consolidated statement of operations, revenues and cost of revenues related to the sale of our gateways and related accessories are classified as “broadband equipment.”

Broadband Software and Services. We offer remote management software, wireless hotspots, web site and store hosting, merchant services and parental controls:

•

Remote management software. We offer two principal remote management software solutions: Netopia Broadband Server and Timbuktu.

•

Our Netopia Broadband Server (“NBBS”) software solution enables carrier-to-customer remote support and management of installed broadband gateways and centralized service delivery (provisioning) for value-added broadband services such as voice, video, data, parental controls, and hot spot access. This solution allows carriers and broadband service providers to provision service and support to their customers on a remote basis and minimize the cost of installation and broadband service provisioning over the lifetime of the relationship with their customer. NBBS can be leveraged to manage both Netopia gateways and other third party devices. The NBBS platform includes optional modules that perform different functions: “Zero Touch” provisioning for the initial installation of broadband equipment at the customer premises and ongoing remote provisioning, administration and support; Hot Spot Manager for the provisioning, authentication and management of hot spot venue access; Parental Controls for Web content filtering and email and chat management; VPN Policy Manager for the setup and administration of secure VPN enabled WAN networks.

•

Timbuktu Pro software provides remote control and computing individual-to-individual and help desk-to-users, for secure remote control of both Mac and Windows personal computers. This solution serves enterprise help desk customers and IT organizations, allowing help desks to provide support and configuration on a remote basis when computer users experience problems or require additional software upgrades for desktop or laptop computers. Remote control of distant computers can use connections over the Internet, local network, or modem to modem. The software enables other users to view all, or part of a

Page 15

computers screen; file sharing; secure, encrypted connections; communication by voice intercom, text chat or instant message. The remote control can be from Mac to PC, or PC to Mac.

•

Web site and Web store hosting. Our eCommerce solutions provide “no assembly required” Web sites and online stores that we call eSites and eStores, and include a wide variety of vertical market content packages to suit many needs, from franchisees to sole proprietors.

•

Wireless hot spots. Our Wi-Fi hot spot services provide high-speed Internet access to a venue’s customers and provides venues with a marketing tool that includes customizable log-in pages, the ability to control access to the hot spot, Family Friendly Surfing content controls, and complete e-Commerce solutions.

•

Merchant service. This broadband service is marketed as the Netopia Merchant Success POS Bundle and provides high-speed wireless Internet Protocol (IP) networking solutions for merchants. This secure solution is designed for retail locations and provides merchants with the benefits of faster credit card payment processing and the ability to implement other value-added services, including real-time check and age authorization, gift cards, ATM and lottery machines, and Wi-Fi hot spots.

•

Parental controls. Our parental controls service enables gateway blocking of adult content and supervision of Internet access. This solution enables control of the home Internet network. This protection includes for each identified user: restricting Internet access by time of day; managing e-mail, chat, and instant messaging; filtering Web sites by category, specific site lists, or high bandwidth. Unlike many competitive products, Netopia’s parental controls operates through the gateway, rather than the desktop, which we believe results in a more secure solution.

During the three months ended March 31, 2005 and 2004, revenue from the sale of our broadband software and services accounted for 12% and 18%, respectively, of our total revenues. During the six months ended March 31, 2005 and 2004, revenue from the sale of our broadband software and services accounted for 11% and 17%, respectively, of our total revenues. When reading our condensed consolidated statement of operations, revenues and cost of revenues related to the sale of our broadband software and solutions are classified as “Broadband software and services.”

We primarily market and sell our products in the United States and in Europe through our sales organization, distributors and value-added resellers. Most of our broadband equipment products are sold to telecommunication carriers and Internet service providers. Our broadband software and services products are generally sold directly to end users. Our sales channels are summarized below.

•

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

•

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

•

Directly to end-users.

We expect that the success of our operations will remain substantially dependent upon our ability to develop products that meet the needs of both the residential and business telecommunications markets.

Telecommunications Market Developments

We expect that the telecommunications market will continue to evolve quickly over the next several years. This change and evolution provides us with significant growth opportunities and risks.

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Incumbent local exchange carriers are responding to competitive challenges in their core voice business particularly from the cable television network operators, which are beginning to use a bundle of voice, video and high-speed data (often referred to as “triple play” services) to gain market share. In response, ILECs are pursuing various strategies of network modernization and service differentiation. We believe that ILECs will add digital video and other services to their offerings, which already includes voice and high-speed data. Examples of other services include streaming live video, music and pictures.

The strategies that ILECs are pursing to modernize their networks include the deployment of all fiber networks and hybrid fiber/copper networks without end-to-end fiber connection by leveraging advanced digital subscriber line technology.

The all fiber network strategy is often referred to as fiber to the premises (“FTTP”). FTTP provides fibers high reliability, ease of service provisioning, and almost unlimited bandwidth. The hybrid fiber/copper network strategy is often referred to as fiber to the neighborhood (“FTTN”) or fiber to the curb (“FTTC”). FTTN and FTTC provide sufficient bandwidth to meet the needs of digital video and other applications. FTTN and FTTC requires the use of very-high-speed digital subscriber line (“VDSL”), a new high performance version of DSL for the connection to the premises. The three largest domestic ILECs, SBC Communications, Verizon and BellSouth, all have announced that they are making substantial investments in the expansion of their fiber optic landline network to residences. The fiber lines enable the ILECs to offer voice, video and high-speed data over one connection. We currently are developing gateways that could be deployed for these new services.

The shift from circuit-switched networks for voice and broadcast networks for video to Internet Protocol-based networks is expected to have a significant impact on the structure of the telecommunications market. This shift may increasingly separate network access and data transport from the services delivered over those networks. For example, there are new companies entering the voice market offering Internet-based phone service.

All of these changes will impact the gateway and gateway software management market in which we compete. For example, as ILECs implement FTTP, FTTN or FTTC as well as new residential home networking solutions, companies that provide gateways, such as ours, may have the opportunity to increasingly compete against incumbent suppliers to best achieve the cost and performance requirements for gateways within the modernized network. While we are positioning our products for this evolving market and will compete vigorously to win new and retain existing telecommunication customers, attracting new or expanded customer relationship could positively benefit our operating performance, while conversely losing customer relationships could negatively harm our operating performance. Given this change, we expect the next several years to be a period of intense competition among gateway providers with both significant opportunities for growth as well as risk of failure.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations are based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with United States generally accepted accounting principles. We review the accounting policies used in reporting our financial results on a regular basis. The preparation of these Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our processes used to develop estimates, including those related to revenue, accounts receivable, inventories, investments, intangible assets and goodwill. We base our estimates on historical experience, expectations of future results, and on various other assumptions that are believed to be reasonable for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. Management on an ongoing basis reviews these estimates and judgments. The Audit Committee of our Board of Directors reviews any changes in our methodology for arriving at our estimates, and discusses the appropriateness of any such changes with management and our independent auditors on a quarterly basis.

Page 17

You should read our 2004 10-K for information pertaining to our critical accounting policies, which include the following:

•

Revenue recognition;

•

Goodwill;

•

Impairment on long-lives assets, including other intangible assets;

•

Allowance for doubtful accounts; and

•

Excess and obsolete inventory.

Liquidity and Capital Resources

The following sections discuss the effects of changes in our balance sheets, cash flows and commitments on our liquidity and capital resources. As of March 31, 2005, our principal source of liquidity included cash and cash equivalents in the amount of $22.7 million, a credit facility with a maximum borrowing capacity of up to $15 million and a borrowing availability as of March 31, 2005 of approximately $6.9 million from which we had no outstanding borrowings.

Cash and Cash Equivalents.


	March 31, 2005		September 30, 2004		Decrease
	March 31, 2005		September 30, 2004		$			%
	(in thousands)
Cash and cash equivalents	$	22,714	$	23,973	$	(1,259	)	-5	%

For the six months ended March 31, 2005, cash and cash equivalents decreased primarily due to the use of cash to fund our operating activities and capital equipment purchases.

Net Cash Used in Operating Activities

Net cash used in our operating activities totaled $1.6 million for the six months ended March 31, 2005, compared to $2.6 million for the six months ended March 31, 2004. Net cash used from operating activities resulted primarily from a net loss of $3.5 million for the six months ended March 31, 2005, partially offset by non-cash depreciation and amortization charges of approximately $1.8 million.

Net Cash Used in Investing Activities

Net cash used in investing activities totaled $0.8 million for the six months ended March 31, 2005, compared to $1.3 million for the six months ended March 31, 2004. Investing activities used approximately $0.8 million of cash for the purchase of capital equipment for the six months ended March 31, 2005.

Net Cash Provided by Financing Activities

Net cash provided from financing activities totaled $1.2 million for the six months ended March 31, 2005, compared to $7.6 million for the six months ended March 31, 2004. Financing activities generated approximately $1.3 million representing proceeds from the issuance of common stock upon the exercise of stock options and the purchase of shares of common stock under the Company’s Employee Stock Participation Plan.

Page 18

Commitments


	Fiscal Years
	2005	2006	2007	2008	2009	Thereafter	Totals
	(In thousands)
Property lease obligations	634	1,107	1,139	809	149	76	3,914

We believe our cash and cash equivalents and cash expected to be generated by our business activities will be sufficient to meet our working capital needs for at least the next twelve months.

Page 19

Results of Operations for the Three and Six Months Ended March 31, 2005 and 2004

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


											Increase / (Decrease)
Three Months Ended March 31,	2005					2004					$			%
	(in thousands, except percentages)
REVENUES:
Broadband equipment	$	22,247		88	%	$	17,878		82	%	$	4,369		24	%
Broadband software and service		2,976		12	%		3,879		18	%		(903	)	-23	%

Total revenues		25,223		100	%		21,757		100	%		3,466		16	%
COST OF REVENUES:
Broadband equipment		16,307		65	%		12,573		58	%		3,734		30	%
Broadband software and service		384		2	%		231		1	%		153		66	%
Amortization of acquired technology		300		0	%		300		1	%		—		0	%

Total cost of revenues		16,991		67	%		13,104		60	%		3,887		30	%
Gross profit		8,232		33	%		8,653		40	%		(421	)	-5	%
OPERATING EXPENSES:
Research and development		3,403		14	%		4,057		19	%		(654	)	-16	%
Selling and marketing		4,582		18	%		5,037		23	%		(455	)	-9	%
General and administrative		2,029		8	%		1,172		5	%		857		73	%
Amortization of intangible assets		87		0	%		87		0	%		—		0	%
Restructuring costs		98		0	%		—		0	%		98		100	%

Total operating expenses		10,199		40	%		10,353		48	%		(154	)	-1	%
Operating loss		(1,967	)	-8	%		(1,700	)	-8	%		(267	)	16	%

											Increase / (Decrease)
Six Months Ended March 31,	2005					2004					$			%
	(in thousands, except percentages)
REVENUES:
Broadband equipment	$	48,444		89	%	$	41,535		83	%	$	6,909		17	%
Broadband software and service		6,097		11	%		8,531		17	%		(2,434	)	-29	%

Total revenues		54,541		100	%		50,066		100	%		4,475		9	%
COST OF REVENUES:
Broadband equipment		36,252		66	%		29,023		58	%		7,229		25	%
Broadband software and service		650		1	%		439		1	%		211		48	%
Amortization of acquired technology		600		1	%		600		1	%		—		0	%

Total cost of revenues		37,502		69	%		30,062		60	%		7,440		25	%
Gross profit		17,039		31	%		20,004		40	%		(2,965	)	-15	%
OPERATING EXPENSES:
Research and development		6,609		12	%		8,008		16	%		(1,399	)	-17	%
Selling and marketing		9,667		18	%		10,063		20	%		(396	)	-4	%
General and administrative		4,224		8	%		2,407		5	%		1,817		75	%
Amortization of intangible assets		173		0	%		173		0	%		—		0	%
Restructuring costs		98		0	%		—		0	%		98		100	%

Total operating expenses		20,771		38	%		20,651		41	%		120		1	%
Operating loss		(3,732	)	-7	%		(647	)	-1	%		(3,085	)	477	%

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REVENUES

Total revenues for the three months ended March 31, 2005 increased from the three months ended March 31, 2004 to $25.2 million or 16% from $21.8 million due to a $4.4 million or 24% increase in revenues from the sale of our broadband equipment products partially offset by reduced revenues of $900,000 or 23% from the sale of our broadband software and services. Total revenues for the six months ended March 31, 2005 increased from the six months ended March 31, 2004 to $54.5 million or 9% from $50.1 million primarily due to a $6.9 million or 17% increase in revenues from the sale of our broadband equipment products offset by $2.4 million or 29% decrease in revenues from the sale of our broadband software and services.

Broadband equipment revenues increased for the three and six months ended March 31, 2005 compared with the same period for the prior year by 24% and 17%, respectively. These increases were primarily attributable to increased unit sales of residential-class ADSL products and accessories, which typically sell at lower average selling prices (“ASP”) than business-class products.

Broadband software and services revenues decreased for the three and six months ended March 31, 2005 compared with the same periods for the prior year by 23% and 29%, respectively. The decreases were attributable to lower sales of licensed software and associated maintenance service agreements.

Product Volumes and Average Selling Price Information

The following table sets forth for three months ended March 31, 2005 and 2004, volumes and average selling prices, excluding accessories, of our broadband equipment products.


Three months ended March 31,	2005		2004
	(volumes in thousands)
Product volumes		248		212
Average selling prices	$	84	$	84

Six months ended March 31,	2005		2004
	(volumes in thousands)
Product volumes		554		474
Average selling prices	$	82	$	88

Cost of Revenues

Cost of revenues consists primarily of material costs of broadband equipment products. The total cost of revenues increased for the three and six months ended March 31, 2005 compared with the same period for the prior year primarily as a result of the increased unit sales and sale of accessories.

Gross Margin

The decreases in gross margins in the three and six month periods ended March 31, 2005 compared with the corresponding period of the prior fiscal year were primarily the result of an increase in unit volume shipments and product mix changes toward residential-class products, which have lower ASPs and lower gross margins than business-class products. In addition, because broadband software and services was a lower percentage of revenues for the three and six month periods compared with the corresponding periods in the prior fiscal year, overall gross margins declined because broadband software and services have higher gross margins than broadband equipment.

Broadband equipment. Gross profit, as a percentage of revenue, decreased for the three months ended March 31, 2005 to 25% from 28% for the same period for the prior year and for the six months ended March 31, 2005 to 24% from 29% compared with the same period for the prior year primarily as a result of decreased ASPs.

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Broadband software and services. The decrease in broadband software and services gross margins reflected the combination of lower software revenue and higher software and service costs. The higher software and service costs reflect increased direct expenses including labor costs.

OPERATING EXPENSES

Research and Development. Research and development (“R&D”) expenses consist primarily of employee related expenses, depreciation and amortization, development related expenses such as product prototyping, design and testing, and overhead allocations. The decrease for the three and six months ended March 31, 2005 compared to the same periods in the prior year was primarily attributable to reduced compensation costs following our restructuring actions in September 2004.

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

Selling and Marketing. Selling and marketing expenses consist primarily of salary and commission expenses for our sales force and related travel expenses and advertising and promotional expenses. The decrease for the three and six months ended March 31, 2005 compared to the same periods in the prior year was primarily the result of increased allocation of costs to cost of services revenues.

We expect that selling and marketing expenses will remain near current levels for the remainder of the current fiscal year, and will fluctuate largely as a result of commission expenses and advertising and marketing initiatives that are related to increases or decreases in sales.

General and Administrative. General and administrative (“G&A”) expenses consist primarily of employee related expenses, legal and accounting fees, and insurance costs. The increase in G&A expenses for the three and six months ended March 31, 2005 compared to the same periods in the prior year was primarily due to increased legal and professional fees incurred in connection with the securities litigation and government investigations related to the restatements of our previously filed financial statements described elsewhere in this Form 10-Q.

We anticipate that G&A expenses for fiscal year 2005 will increase as a result of the ongoing legal expenses related to the securities litigation and government investigations described elsewhere in this Form 10-Q, as well as increased expenses related to implementation of Section 404 of the Sarbanes-Oxley Act, which requires our management to assess the effectiveness of our internal controls over financial reporting.

Amortization of Other Intangible Assets. For the three and six months ended March 31, 2005 and 2004, amortization of other intangible assets represents the amortization of intangible assets with identifiable lives related to our acquisitions of Cayman and JadeSail (See Note 5 of Notes to Unaudited Condensed Consolidated Financial Statements included in this Form 10-Q).

Restructuring Costs. During the three months ended March 31, 2005, we recorded a restructuring charge of $98,000, primarily consisting of employee termination costs and wind down costs associated with the closure of a sales office in the Netherlands and additional wind down costs associated with the prior closure of the Germany development office.

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Risk Factors

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

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

During the three months ended March 31, 2005, we incurred a net loss of $1.8 million and used approximately $1.6 million of cash for operating activities. We incurred losses from continuing operations of $9.0 million and $8.3 million for the fiscal years ended September 30, 2004 and 2003 respectively, and used $5.2 million and $5.4 million of cash during the fiscal years ended September 30, 2004 and 2003, respectively. Our cash and cash equivalents totaled $22.7 million at March 31, 2005. We may not be able to reach, sustain or increase profitability or generate cash on a quarterly or annual basis, which could significantly harm our business.

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

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

If we are unable to resolve pending private securities litigation and the government investigations related to and arising out of the restatements of our consolidated financial statements for prior periods in a timely and economic manner, our business could be significantly harmed.

We currently are named as a defendant in a consolidated private securities action brought as a purported class action. In addition, there are purported derivative actions pending in state and federal court in California. We also are the subject of a formal order of investigation by the Securities and Exchange Commission to determine whether the federal securities laws have been violated. We recently learned that the United States Attorney for the Northern District of California has opened an investigation following a referral by the SEC. Responding to the formal order of investigation of the SEC has required and will continue to require significant attention and resources of management. If the SEC elects to pursue an enforcement action, the defense could be costly and require additional management resources. If we were unsuccessful in defending against this or other investigations or proceedings, we could face civil or criminal penalties that would seriously harm our business and results of operations. We do not know the scope or focus of the investigation by the United States Attorney’s office. Defending against the government investigations and the private securities class action and derivative actions also will likely require significant attention and resources of management and, regardless of the outcome, result in significant legal expense. If our defenses ultimately are unsuccessful, or if we are unable to achieve a favorable settlement, we could we liable for large damage awards that could seriously harm our business and results of operations. While we have provided notice of the government investigations and the private securities class action and derivative actions to our directors and officers liability insurance carriers, the insurance carriers have raised certain coverage issues and have not reimbursed us for any legal

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expenses incurred, and may not agree that they are responsible to pay any damages that ultimately could be awarded to the plaintiffs. Furthermore, we have only a limited amount of insurance, and even if our insurers agree to make payments under the policies, the damage awards or settlements may be greater than the amount of insurance, and we would in all cases be liable for any amounts in excess of our insurance policy limits.

Substantial sales of our broadband equipment will not occur unless telecommunications carriers and service providers continue to expand their deployments of DSL and other broadband services, and without continued expansion our revenues may decline, which could significantly harm our business.

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

•

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

•

Improved business opportunities provided by deployment of broadband services by our ILEC and other customers;

•

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

•

Rapidly changing industry standards for DSL and other broadband technologies; and

•

Government regulations.

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

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

ILECs have been aggressively marketing DSL services principally focusing on residential services. We have committed resources that are working to expand our sales in the ILEC channel both domestically and internationally. There continue to be barriers associated with such sales including, but not limited to, lengthy product evaluation cycles, the difficulty in dislodging competitors whose products are currently being utilized, long-term product deployment cycles and intense price competition. ILECs currently obtain equipment from our competitors, which include 2Wire, Inc., Westell Technologies, Inc., Siemens AG (through its Siemens Subscriber Networks, Inc. subsidiary, formerly known as Efficient Networks), Thomson Corporation and ZyXEL Communications Co., which have proven to be strong competitors. All of these competitors are larger than us and may have greater financial resources. There is no guarantee we will be successful in expanding our presence in the ILEC market. If we fail to further penetrate the ILEC market for our products and services, our business may be materially and adversely affected.

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

Prior to our acquisition of Cayman in October 2001, we developed, marketed and sold broadband equipment products primarily to CLECs and ISPs serving the small business market for DSL Internet connectivity. We now have products and technology that allow us to compete effectively for sales of broadband equipment to ILECs serving the residential market. There are numerous risks associated with the residential broadband gateway market including, but not limited to:

•

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

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•

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

•

Intense price pressure.

If we are unable to increase our sales to ILECs and our market share of residential-class broadband gateways, our business will be materially and adversely affected.

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

We rely on a small number of customers for a large portion of our revenues. For both the three months ended March 31, 2005 and the fiscal year ended September 30, 2004, there were five and four customers, respectively, that each individually represented at least 5% of our revenues and in the aggregate, accounted for 59% and 60%, respectively, of our total revenues. Our revenues will decline and our business may be significantly harmed if one or more of our significant customers stop buying our products, or reduce or delay purchases of our products.

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

A substantial portion of our revenues is derived from sales to international customers, mainly in Europe. For the three months ended March 31, 2005 and the fiscal year ended September 30, 2004, our international sales represented 36% and 44%, respectively, of our total revenues. We expect sales to international customers to continue to comprise a significant portion of our revenues. Sales of broadband equipment products to many of our European customers are denominated in Euros. For our international sales that continue to be denominated in United States dollars, fluctuations in currency exchange rates could cause our products and services to become relatively more expensive to our foreign customers, which could result in decreased sales of our products and services. In addition, changes in the value of the Euro relative to the United States dollar could adversely affect our operating results to the extent we do not adequately hedge sales denominated in Euros.

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

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

•

Costs of customizing products for foreign countries;

•

Laws and business practices favoring local competitors;

•

Dependence on local vendors;

•

Uncertain regulation of electronic commerce;

•

Compliance with multiple, conflicting and changing governmental laws and regulations;

•

Longer sales cycles;

•

Greater difficulty in collecting accounts receivable;

•

Import and export restrictions and tariffs;

•

Difficulties staffing and managing foreign operations;

•

Multiple conflicting tax laws and regulations; and

•

Political and economic instability.

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

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

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

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

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

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

Our revenues and operating results have varied in the past and are likely to vary in the future from quarter to quarter. For example, during the past eight quarters ended March 31, 2005, our revenues have ranged from $21.8 million to $29.3 million, and our net results have ranged from $1.2 million of income to a loss of $6.1 million. As a result, we believe that period-to-period comparisons of our operating results are not necessarily meaningful. Investors should not rely on the results of any one quarter or series of quarters as an indication of our future performance.

In certain quarters in the past, our operating results were below the expectations of securities analysts, it is likely that in some future quarter, quarters or year, our operating results again will be below the expectations of securities analysts or investors. When our operating results are below such expectations, the market price of our common stock may decline significantly. In addition to the uncertainties and risks described elsewhere under this “Risk Factors” heading, variations in our operating results will likely be caused by factors related to the operation of our business, including, but not limited to:

•

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

•

Increased price competition for our broadband equipment products;

•

Our ability to license, and the timing of licenses, of our broadband software and services;

•

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

•

The price and availability of components for our broadband equipment; and

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•

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

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

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

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

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

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

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

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

We compete in markets characterized by continuing technological advancement, changes in customer requirements and evolving industry standards. To compete successfully, we must design, develop, manufacture and sell new or enhanced products and services that provide increasingly higher levels of performance, reliability, compatibility, and cost savings for our customers. We will need to continue to

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integrate our DSL modem and router technology with the architectures of leading central office equipment providers in order to enhance the reliability, ease-of-use and management functions of our broadband equipment.

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

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

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

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

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

The majority of our broadband software and services revenues are derived from the sale of software products for corporate help desks, mostly Timbuktu. For the three months ended March 31, 2005 and the fiscal year ended September 30, 2004, revenues from help desk applications were 66% and 70%, respectively, of total revenues for our broadband software and services products. We anticipate that the market for Timbuktu may continue to decline or grow more slowly than the market for our other broadband software products and services. We also have not generated significant revenues to date from the NBBS software platform. In addition, we rely on a small number of licensees to promote the use of our broadband software and services for building web sites and stores. As a result, we derive the majority of the recurring revenues from our broadband software and services products from fewer than five customers. The extent and nature of the promotions by licensees of our broadband software and services are outside of our control. If licensees of our eSite and eStore software do not successfully promote web sites and stores to their customers, we will not generate continued recurring revenues. If these customers were to choose a competitive platform, this could lead to reduced revenues and adversely impact our results.

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

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

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

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

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

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

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

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

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

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

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

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

We believe that a small number of stockholders hold a large portion of our common stock. One of our directors owns approximately 3.7% of our common stock outstanding at March 31, 2005. To the extent any of our large stockholders decides to sell substantial amounts of our common stock in the public market over a short period of time, based on the historic trading volumes, we expect the market price of our common stock could fall.

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

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

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

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

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

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

•

Our ability to meet the listing standards and to obtain a relisting of our common stock on The NASDAQ Stock Market or a listing on The NASDAQ SmallCap Market;

•

Variations in our quarterly operating results, including shortfalls in revenues or earnings from securities analysts’ expectations;

•

Changes in securities analysts’ estimates of our financial performance;

•

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

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•

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

•

General conditions in the broadband communications industry.

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

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

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

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PART I — FINANCIAL INFORMATION

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risks

Our potential market interest rate risk for borrowings relates primarily to the rate charged by Silicon Valley Bank under our credit facility, from which we had no borrowings at March 31, 2005. The credit facility bears interest at a rate equal to the prime rate (the rate announced by Silicon Valley Bank as its “prime rate”) as long as no default or event of default has occurred and is continuing, and as long as we maintain profitability as of the end of each fiscal quarter. If a default or an event of default has occurred and is continuing or we cannot maintain profitability, the interest rate on the credit facility would change to the prime rate plus 0.75% per annum. To the extent interest rates increase and we make borrowings under the credit facility, we would incur increased interest expense.

Foreign Currency Risks

Our exposure to foreign exchange risk relates primarily to sales and corresponding receivables made to international customers whose related transactions are denominated in Euros. We are subject to risks typical of an international business including, but not limited to, differing economic conditions and tax structures, other regulations and restrictions and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors. To minimize the effects of potential short-term fluctuations on our operating result stemming from our exposure to foreign currency changes, we enter into currency exchange forward contracts. These contracts guarantee a predetermined exchange rate at the time the contract is purchased. In March 2005, we entered into a forward contract to hedge the exposure to changes in the fair value of our accounts receivable for March 2005, which were denominated in Euros. Our currency exchange contracts typically have a maturity of less than three months.

The table below presents the carrying value, in United States dollars, of accounts receivables denominated in Euros at March 31, 2005 and 2004. The accounts receivables at March 31, 2005 were valued at the United States/Euro exchange rate on March 31, 2005 and the accounts receivables at March 31, 2004 were valued at the United States/Euro exchange rate on March 31, 2004. The carrying values approximate fair value at March 31, 2005 and 2004.


	2005			2004
Three Months Ended March 31,	Carrying amounts		Exchange rate	Carrying amounts		Exchange rate
Principal (notional) amounts in United States Dollars:
Accounts receivable denominated in Euros	$	3,364	1.2916	$	2,747	1.2178

As of March 31, 2005, the Company had entered into a foreign currency forward contract that has the effect of fixing the exchange rate on Euro 900,000 at $1.3117 until the April 29, 2005 settlement date.

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PART I — FINANCIAL INFORMATION

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

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

Changes in internal controls

During the three months ended March 31, 2005, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

As described in greater detail in the 2004 10-K in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, we restated our financial statements for the fiscal years ended September 30, 2002 and 2003, and our interim financial statements for the fiscal quarters ended December 31, 2003 and March 31, 2004. As a result of the Internal Accounting Review commenced in July 2004, we filed the Forms 10-Q for the third fiscal quarter ended June 30, 2004 and the 2004 10-K on February 1, 2005, which was later than the designated filing deadlines.

In response to the matters discovered in connection with the Internal Accounting Review, we have taken, and will continue to take, steps to strengthen control processes and procedures to identify, rectify and prevent the recurrence of the circumstances that resulted in the restatement of prior period financial statements. With respect to such identified weaknesses, we intend to continue to improve our internal controls and procedures by taking the additional following steps, among others:

•

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

•

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

•

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

•

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

We believe changes to our system of internal controls and our disclosure controls and procedures will be adequate to provide reasonable assurance that the objectives of these controls will be met. We intend to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and to improve our controls and procedures over time and to correct any deficiencies that we may discover in the future. Our goal is to ensure that our senior management has timely access to all material financial and non-financial information concerning our business. While we believe the present design of our disclosure controls and procedures is effective to achieve our goal, future events affecting our business may cause us to modify our disclosure controls and procedures. Furthermore, because of

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the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.

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

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ITEM 4A.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On March 18, 2005, we held our Annual Stockholder Meeting in Emeryville, California. At the Annual Stockholder Meeting, the stockholders voted on the following proposals:

To elect six (6) directors to serve until the 2006 Annual Stockholder Meeting or until their successors have been elected and qualified or until their earlier resignation, death or removal;

To approve our 2005 Employee Stock Purchase Plan and to authorize 1,225,000 shares of Common Stock for issuance under the plan; and

To ratify the appointment of Burr, Pilger & Mayer LLP as our independent auditors for the fiscal year ending September 30, 2005.

The votes cast for, against or withheld, as well as the number of abstentions, is set forth below as to each matter voted upon at the meeting:


	For	Withheld	Against	Abstain
Item 1:
Election of Directors
Harold S. Wills	22,029,665	765,926
Alan B. Lekof	22,173,434	622,157
Reese M. Jones	21,776,910	1,018,681
Robert Lee	22,121,073	674,518
David F. Marquardt	22,024,454	771,137
Howard T. Slayen	22,017,226	778,365

Item 2:
Approval of Employee Stock Purchase Plan	6,056,931		1,706,849	153,389

Item 3:
Ratify Appointment of Independent Auditors	22,650,530		95,431	39,630

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PART II — OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

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

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ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits


Exhibit Number		Description

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) We filed the following Current Reports on Form 8-K during the three months ended March 31, 2005:

•

On February 1, 2005, we filed a Current Report on Form 8-K, reporting Items 2.02 and 9.01, reporting our financial results for our fourth fiscal quarter and fiscal year ended September 30, 2004, as well as certain other information.

•

On February 9, 2005, we filed a Current Report on Form 8-K, reporting Items 2.02 and 9.01, reporting our financial results for our first fiscal quarter ended December 31, 2004, as well as certain other information.

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SIGNATURES

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


Date: May 10, 2005	NETOPIA, INC. (Registrant)

	By:	/s/ Alan B. Lefkof
		Alan B. Lefkof
		President and Chief Executive Officer

	By:	/s/ Mark H. Perry
		Mark H. Perry
		Interim Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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