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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

Form 10-K

(Mark One)

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended March 26, 2004

OR

¨

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

For the transition period from ______________ to ______________

Commission File Number 0-15323

NETWORK EQUIPMENT TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

6900 Paseo Padre Parkway
Fremont, California 94555-3660
(510) 713-7300
(Address of principal executive offices, including zip code and telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

7 1/4% Convertible Subordinated Debentures
(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).   Yes x      No ¨

The aggregate market value of voting and non-voting common stock held by non-affiliates of the registrant (based on the closing price for the common stock on the New York Stock Exchange on September 26, 2003, which is the last business day of the Registrant’s most recently completed second fiscal quarter) was approximately $214,200,036.  Shares of common stock held by each officer and director and by each person who owns 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of the Common Stock, $0.01 par value on June 3, 2004 was 24,272,420.

DOCUMENTS INCORPORATED BY REFERENCE:

The registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on August 10, 2004 is incorporated by reference in Part III of this Form 10-K to the extent stated herein.

NETWORK EQUIPMENT TECHNOLOGIES, INC

FORM 10-K

March 26, 2004

TABLE OF CONTENTS

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PART I

Forward-Looking Statements

Statements contained in this Form 10-K that are not historical facts are forward-looking statements within the meaning of the federal securities laws that relate to future events or our future financial performance.  A forward-looking statement may contain words such as “plans,” “hopes,” “believes,” “estimates,” “will continue to be,” “will,” “continue to,” “expect to,” “anticipate that,” “to be,” or “can impact.”  Forward-looking statements are based upon management expectations and involve risks and uncertainties that may cause actual results to differ materially from those anticipated in the forward-looking statements.  Many factors may cause actual results to vary including, but not limited to, the factors discussed in this Form 10-K.  We expressly disclaim any obligation or undertaking to revise or publ icly release any updates or revisions to any forward-looking statement contained in this Form 10-K. Investors should carefully review the risk factors described in this document along with other documents we file from time to time with the Securities and Exchange Commission.

ITEM 1.  BUSINESS

Overview

Network Equipment Technologies, Inc., doing business as net.com since 2000, is a global provider of networking technology platforms that are used for mission-critical communications solutions.  Network Equipment Technologies, Inc. was founded in 1983.  Our multiservice wide area networking (WAN) products, comprising the Promina product line, provide a platform that delivers highly efficient bandwidth utilization on circuit-switched networks, and is tailored to highly reliable and secure communications. In response to the growth of broadband networks using packet-switching technologies and the Internet protocol (IP), we developed our service creation products, offering platform consolidation, network migration, and capabilities for the delivery of next-generation services such as voice or video over IP. These broadband platforms allow network service providers to rapidly create and deliver new service offerings that we believe can help them to accelerate the return on their network investment, reduce capital and operating expenditures, and achieve greater profits.

Our objective is to become a leader in the telecommunications equipment industry by providing platforms that enable service providers to achieve a greater potential for increased revenue and profitability through the delivery of services differentiated by class and quality on an open platform that facilitates the creation of new services.  We additionally address service provider needs to lower the cost of operations through more efficient provisioning of resources, automation, and on-demand provisioning by users, together with reduced training requirements and lower equipment and facilities costs via the consolidation of multiple technologies onto a single platform.  

We have a worldwide customer base that includes governmental entities, telecommunications service providers, and enterprise customers in North America, Latin America, Europe, the Middle East, and Asia. Our growth over the past three years was primarily due to our government business.  Our government customers include but are not limited to U.S. defense and intelligence agencies, civilian agencies such as the Federal Emergency Management Agency, the Federal Aviation Administration, and international organizations such as NATO and foreign defense ministries.

Our global support and service organization, along with third-party service organizations, provides installation, maintenance, technical assistance and customer training.

Industry Background

Among the significant advances in networking technologies over the past decade is the increasing use of packet switching to divide information into relatively small packets for transportation over a network. Packet switching enables convergence of disparate applications onto a single packet infrastructure, allows use of public infrastructure rather than requiring dedicated network lines, and is particularly well suited to the fast transmission of high volumes of information, often referred to as “broadband” communications. In contrast, circuit-switching makes use of dedicated or leased lines to provide secure and deterministic transmission of communications. Historically, circuit-switched technology has been used by the Public Switched Telephone Network (PSTN) and for the transmission of relatively low-to-medium volumes of information, often referred to as “narrowband” communications.

Due to its capabilities for the fast transmission of high volumes of information, there has been an increasing adoption of packet-switched networks and equipment. This technology transition was slowed somewhat by the difficult economic and regulatory environment in the telecommunications market over the past few years, as well as renewed interest in secure communications following the events of September 11, 2001. Also, telecommunications service providers have historically made incremental changes with proven technology, including circuit-switched equipment, rather than wholesale changes to their networks. Nonetheless, we believe that telecommunications equipment customers, including carriers and service providers, will continue to adopt newer technology that leverages the inherent benefits of packet-switching, for greater capacity, increased flexibility, and lower cost.

Telecommunications service providers have faced a number of challenges resulting from changes in the telecommunications market in recent years.  With the rapid growth of the Internet and the development of advanced communications applications such as video and audio content on demand, wireless access, and video conferencing, the telecommunications industry foresaw enormous growth in the demand for network capacity. Carriers and service providers rapidly built out their core infrastructure to accommodate expected surges in IP traffic. In addition, alternative broadband access technologies were developed and commercialized, including Digital Subscriber Line (DSL), digital cable, and, more recently, wireless. Although demand for broadband communications has continually increased, numerous factors created a hyper-competitive telecommunications environment that has prevented many carriers and service providers from earning an adequate return on their capital expenditures. These factors include deregulation in the telecommunications industry, homogeneity and commoditization of transport services, and excess capacity from over-investment. The pressure on carriers has been exacerbated by the high costs and difficulties in deploying DSL services, which slowed the rate of adoption and limited revenue growth, as well as the success of cable providers in capturing a large share of new residential broadband customers. These challenges have come at the same time that carriers are experiencing a decline in revenue from their local voice networks as households turn to other sources for voice services, such as wireless communications, cable and, increasingly, their Internet connections.

As carriers and service providers seek to address the competitive pressures in the communications market, they are focusing on architectural changes that can make their investments in broadband profitable on a long-term basis. In mid-2002, the North American incumbent carriers (BellSouth, SBC Communications, Verizon Communications, and Bell Canada) together submitted a draft document to the DSL Forum, which is primarily composed of equipment vendors. This draft, which became Technical Report 059 (TR-059) of the DSL Forum, offers a proposal for a unified architecture for DSL connections, enabling carriers to deliver tiered services across multiple networks and via multiple carriers. It also provided a roadmap for competing with cable providers. The proposal increases the number of services available via DSL and offers a real-time, on-demand capability for users of DSL services. Ideally, the new architecture will enable carriers to creat e a new layer of network intelligence that supports the widespread deployment of comprehensive and affordable integrated service packages from which they can develop strategies for tiered classes of services, varied levels of quality of service dependent on application requirements, and offerings for dynamic selection of services and self-provisioning by DSL customers. This new network architecture represents a potential opportunity for telecommunications equipment providers to deliver new products that carriers can use at the edge of their existing networks to create and deliver new, differentiated DSL services.

Business Strategy

Our business strategy includes the following key elements:

Leverage market position and revenue contribution of our Promina customer base. net.com was a pioneer of the concept of multi-service networking and has been delivering these mission-critical capabilities for over twenty years. The installed base and revenue contribution from our narrowband Promina product line continues to be the majority of our revenue today.  The Federal Government and other customers around the world have continued to deploy new networks using Promina, due in part to its time-proven ruggedness, reliability and capabilities for secure communications. We believe that we are well positioned to leverage our installed customer base, particularly the government, for sales of our broadband and IP telephony platforms.  Our new SCREAM platform is currently being sold to government customers globally and is in various stages of evaluation with several incumbent service providers.  With recent product developments, including our SCREAMlink program, secure voice enhancements to the SHOUTIP platform, and the addition of Cisco’s IOS (Internetworking Operating System) to the SCREAM platform, we have the opportunity to strengthen our position within the Federal Government for new applications, as well as replace equipment of legacy competitors.

Design and develop industry leading broadband hardware and software service creation solutions to meet opportunities in the customers’ networks. We consider our technological and product leadership to be critical to our future success. Having developed the essential product platforms that address our target markets, additional refinements will enable us to meet increasing customer requirements. We must continue to enhance our SCREAM platform to meet the service providers’ current rollout plans for new technology in their networks. The latest release of our SCREAM platform delivers critical requirements of TR-059, but the service providers continue to define their specific needs. Additionally, in the development of our new products and continuing engineering of existing products, we strive to provide a migration path from current technologies. Specifically, enhancements to Promina and our SCREAMlink pr ogram are designed so that current customers can leverage their investments and more cost-effectively migrate to our new broadband technologies.

Target a global array of carriers as potential customers for our SCREAM product line. Carriers from around the globe are now participating in the DSL Forum initiative involving the TR-059 reference architecture. In the United States, the incumbent carriers face a number of challenges, including regulatory uncertainties, that could further delay their deployment of the equipment that will enable differentiated services, until the end of calendar year 2004 or later.  In the near term, we are focusing on additional carrier opportunities both within the U.S. and internationally, while remaining engaged with the U.S. incumbent carriers and Bell Canada. These additional carrier opportunities include the tier two and three carriers in the U.S. (Independent Operating Companies, or IOCs, and Competitive Local Exchange Carriers, or CLECs), tier one and two carriers in Europe, and tier one carriers in emerging econom ies in Eastern Europe, Latin America, Asia and the Middle East.

Leverage relationships with key partners. We continually seek to establish relationships with third-party application software vendors, product original equipment manufacturers (OEMs), resellers and our customers.  net.com also seeks relationships with the large incumbent vendors globally that could facilitate our entry and success in incumbent carriers’ networks. In June 2002, net.com co-founded the Service Creation Community along with Accenture, ADC Telecommunications, Microsoft, Oracle, Paradyne, and Siemens. The Community is a non-profit independent alliance of equipment vendors, technology and infrastructure suppliers, integrators, and service/content providers dedicated to the rapid creation and delivery of new content and communications services. We have taken a leadership position within the Community, engaging service provider end customers to define pilot solutions that member companies can develop and deliver.

Provide value-added service and system integration capabilities. Since our inception, we have viewed customer service and support as a key element of our overall strategy and a critical component for our long-term relationship with customers. Customers around the world turn to us not only for the reliability and performance of our products but also for our comprehensive support services that optimize the value of those products. Additionally, by offering an upgrade path to new products in lieu of costly “time and materials” options for long-discontinued products, we are able to reintroduce ourselves to customers who recognize our tradition for building high performance, reliable and well-supported products.

Continue to improve business operations and profitability.  Last year, we achieved certification under the ISO 9001:2000 standards, a refined product life cycle process, and new service solutions, and we are currently investing in TL9000, the telecommunications-specific set of requirements based on ISO 9001. We recently updated our NEBS (network equipment - building systems) certification, along with carrier-specific certifications for SBC and Verizon, for the latest release of our SCREAM platform. Other company initiatives continue to focus on inventory management, supply chain flexibility, and internal controls. Collectively, these initiatives are designed to allow us to reduce our operating costs and increase gross margins, operating income and cash flow, while also preparing us to participate in tier-one carrier markets, and to support higher growth rates without having to invest in additional res ources.

Products

Promina — Narrowband Multiservice Access Platforms

Our Promina family of multi-service access platforms integrates voice, data, image and video traffic across a single network infrastructure. The Promina platform, tailored to circuit-switched networks, provides mission-critical support for a wide variety of communications applications and traffic types, including asynchronous transfer mode (ATM), frame relay, IP, and integrated services digital network (ISDN) signaling. Promina products offer a broad range of user-side interfaces, enabling standards-based connection of communications equipment, whether located at a service provider’s switching facility or at an enterprise or government customer’s premises.

The Promina platform features advanced network management services, which provide a high degree of visibility into network operations. For fault tolerance and high network reliability, our Promina products can be configured with redundant power, memory, common logic, and trunk interfaces. Internally, these products incorporate distributed network intelligence that allows the network to quickly and automatically reroute traffic in the event of failure of a component. Additionally, Promina’s modular design, with application and interface modules that are interchangeable across the product series, provides great flexibility and scalability, especially important in a quickly changing communications environment and also in rapid deployment for field operations.

The Promina product family includes a range of systems for various node sizes, with various processor, application, and interface modules. We now offer a broadband migration path for Promina customers with the SCREAMlink program. SCREAMlink allows Promina customers to protect their investments in existing architectures while accommodating immediate needs through a logical migration to a hybrid Promina/SCREAM solution, monitored and controlled by netMS, an integrated network management solution. Additionally, for the Promina product family, we have taken steps this year under our TopSpin initiative to increase the functionality of various cards that were facing component obsolescence from our suppliers.  We expect this initiative to result in reduced costs for these cards and to enhance the competitive positioning of our Promina product line and potentially extend its product life cycle.

In fiscal 2004, 2003, and 2002, our Promina products accounted for 86.3%, 80.9%, and 87.1% of product revenue, respectively.

SCREAM — Broadband Services Delivery Platform

The SCREAM^® platform enables service providers to dynamically define, deliver, and manage new broadband services. SCREAM is a universal broadband services switch designed to support a broad array of services delivered through DSL and other access networks such as cable, fiber and wireless. Built from the ground-up for the carrier environment, SCREAM is also well suited for government and international enterprise customers wishing to add or connect broadband services to their existing networks. The SCREAM platform’s processing power can closely examine DSL subscriber traffic, and apply special handling instructions based on specific policies, all at “wire speed,” meaning as fast as transmission speed. This enables service providers to differentiate broadband services based on subscriber identity, user requirement or application, and monitor and report billable events, all in real time. As a result, service providers using SCREAM have a means to generate incremental revenue from innovative services based on factors such as broadband content delivery, IP quality-of-service (QoS) guarantees, class-of-service (CoS) subscriptions, and dynamic bandwidth allocation.

SCREAM delivers single-platform integration of broadband aggregation and subscriber management, IP services, ATM switching, edge routing, and broadband service creation. By aggregating a broad range of services and historically disparate technologies on a single platform, SCREAM can help service providers reduce their capital equipment expenditures while they advance their broadband service offerings. SCREAM functions at the edge of a service provider’s network, where service providers can launch new services directly to customers without re-architecting their core network.

The SCREAM platform is architected to enable service provider or third-party solutions to be readily implemented using an open programming interface, which allows for a rapid and cost-effective integration to operational and business support systems. The latest release of our SCREAM platform delivers three critical requirements of TR-059 in a single platform: full ATM switching, IP routing via Cisco’s IOS, and richly featured BRAS (broadband remote access server) required for effective subscriber management. These capabilities enable our customers to achieve support for legacy services while providing a practical multiservice switching upgrade to their network. To the extent that these capabilities are integrated into a single product, service providers can reduce both capital expenditures and operating expenses, from automated provisioning of services to reduced real estate, energy and training expenses. In addition, for carriers that must continue to operate both ATM and IP networks, managing traffic through a single platform simplifies network policy management.

net.com has rights to use Cisco’s IOS pursuant to a long-standing relationship with Cisco. Cisco technology dominates the market for core network routers. We believe that we have significant competitive advantages by having access to this technology, including access to Cisco development streams of technology such as MPLS (multiprotocol label switching), one of the developing technologies in networking used to deliver and manage quality-of-service differentiation, which we intend to include in a future release of SCREAM. We leverage Cisco’s command line interface (CLI) to provide near plug-and-play compatibility for customers with Cisco-powered networks, including carriers and the government.

netMS — Integrated Element Management

netMS is an element management system for managing both Promina and SCREAM devices and networks in one platform. netMS provides network discovery and device discovery, builds a topology view, displays alarms and events, and can be used for many configuration tasks. netMS has a web-based user interface for rapid deployment and ease of use, and is scalable to manage large networks and deliver aggressive performance metrics.

SHOUTIP — IP Telephony Gateway

SHOUTIP is a flexible IP telephony platform that supports a variety of voice services, such as long-distance voice over IP (VoIP), hosted IP telephony, calling card services, and interactive voice response (IVR) solutions such as call centers and help desks. SHOUTIP merges call control signaling and transport functionality into a single platform. The system’s advanced protocol translation, along with industry standard interfaces and integrated support for SS7 signaling, allows voice service providers to interconnect with multiple signaling protocols from autonomous networks. This compatibility or interoperability with existing vendors and networks reduces the risks for service providers or enterprises to switch to or incorporate the SHOUTIP platform. The carrier-class SHOUT2500 platform, announced in April 2002, supports one to 32 T1/E1 connections or up to 960 simultaneous voice calls, all in a five-inch high chassis that can be easily configured for a variety of services. The SHOUT2500 platform reduces space requirements by eliminating multiple stand-alone devices and the complex integration efforts required by other solutions on the market.

The SHOUTIP product family also includes the SHOUT900 platform and SHOUTlink. The SHOUT900 supports one to eight T1/E1 connections or 240 simultaneous voice calls, with support for secure telephone units (STU) and calling card applications, in a chassis 1.75 inches high. SHOUTlink enables the interconnection of SHOUTIP to networks using existing standards-based signaling protocols.

This year, we invested in significant development on the SHOUTIP platform to deliver secure voice applications for the government. The Federal Government uses a variety of special phones to facilitate secure communications.  SHOUTIP allows these phones to be used over IP networks, thus enabling a secured voice technology to be readily deployed. SHOUTIP has been trialed and tested by entities within the Defense Information Systems Agency (DISA), with initial deployments of early technology by Centcom (the Central Command forces) for the Kuwait-Iraq Command Control, Communications and Computers Commercialization (KICC) program. We believe we offer a unique solution to the government’s requirements for secure VoIP technology by substantially increasing the utilization of the limited bandwidth available over satellite links, thereby reducing the cost of satellite communications.

Customers and Markets

net.com pioneered the concept of multiservice networking and has been delivering these capabilities for nearly 20 years. The focus of our narrowband Promina product has been on governments and large enterprises, as well as carriers for their enterprise business and the delivery of leased-line service, and it is also sold to global information and financial services companies. The primary focus of our broadband SCREAM product family is on telecommunications carriers, while the SCREAMlink program enables our carrier, government and enterprise customers to migrate gracefully to next-generation IP networks. For both our broadband and narrowband products, we focus primarily on information and communication-intensive organizations. These customers may be local, national, or global in their operations.

SCREAM is designed for the stringent demands of the carrier market. The specific physical requirements of the SCREAM platform meet the demanding specifications of the incumbent carriers’ environment, including a small footprint, front access, and reduced power consumption.

We have targeted our Promina product line at government customers, service providers and enterprises. In the service provider marketplace, carriers use Promina networks for backbone services.  Current enterprise customers include corporations representing the financial, banking, insurance, energy, transportation, manufacturing and retail sectors. Government customers represent a variety of federal and international agencies and organizations, including civilian and defense agencies.

Sales to the Federal Government and its agencies represented 73.3%, 64.6%, and 50.4% of net.com’s revenue in fiscal 2004, 2003, and 2002, respectively. net.com does business with the government both as a direct contractor and as a subcontractor. Many of our products and services are purchased through GSA schedules or through direct contracts, such as with the Department of Defense (DoD) and NATO, and these contracts may also be used by other government agencies. See discussions in Business Environment and Risk Factors in this Form 10-K.  Beyond government customers, the Promina product line currently has more demand outside the United States than within the United States, especially in emerging markets such as Eastern Europe, China, and Latin America where telecommunications infrastructure is relatively underdeveloped. Applications that can be enabled by Promina-based solutions include digital data networks (DDNs) that provid e basic data services in these emerging markets. International sales represented 18.6%, 24.9%, and 30.9% of net.com’s revenue in fiscal 2004, 2003, and 2002, respectively.

Other than orders from a variety of agencies in the U.S. Federal Government, no single customer accounted for more than ten percent of net.com’s revenue in fiscal 2004, 2003 or 2002.

Competition

The market for telecommunications equipment is highly competitive and dynamic, has been characterized by rapid changes to and the convergence of technologies, and has seen a worldwide migration from existing circuit technology to the new packet-based technologies. We compete directly, both internationally and domestically, with many different companies, some of which are large established suppliers of end-to-end solutions such as Alcatel, Cisco, Juniper, Lucent, Nortel and Siemens. Most of the large suppliers have greater financial, marketing and technical resources and offer a wider range of networking products than we do. These suppliers can often provide a complete network solution rather than a partial solution that may make their products more attractive to potential net.com customers. However, these companies have also suffered from the industry decline, and many have eliminated entire divisions, leaving the carriers with concern s about support for the larger vendors’ products, as well as for the ability of smaller companies to support them. SCREAM competitors include Juniper, Cisco, Copper Mountain, Nortel, and Redback. For our SHOUTIP product line, competition includes the established market leader, Cisco, and smaller companies such as Nuera and Vocality.

Sales

We sell our products and services through both direct and indirect sales channels worldwide. We believe that to effectively market and sell our products, a local sales organization is beneficial to understand the business and network environment of local countries. We also believe that a sales force effort supported by sales engineers who provide customers with pre-sale and post-sale technical assistance allows net.com to gain more in-depth knowledge of customers’ network requirements. We have approximately 60 sales personnel located in nine countries. This sales effort is supported through a variety of channel partners. Our business is generally not seasonal, though we may be affected by end of the year spending patterns of the Federal Government at its September end of year, which in most years is just after the end of our fiscal second quarter.

We sell products and services in North America primarily through direct channels, although we make use of a small number of distributors and integrators in some markets, especially for the SHOUTIP product line. Our international sales are made almost entirely through indirect channels that are augmented by the efforts of a local sales force. In addition to the marketing and sale of products, international resellers provide system installation and technical support. In most cases, international resellers have non-exclusive agreements to resell net.com products within particular geographic areas. Resale agreements do not contain a sales commitment or required sales quota.

We sell to governments through net.com’s wholly owned subsidiary, N.E.T. Federal, Inc. (N.E.T. Federal), which sells products both directly and through collaborative government contracting and by contracting agencies at their convenience or at annual intervals. N.E.T. Federal supports sales to the Federal Government’s defense and civilian sectors and to government agencies worldwide. Sales to governments include sales under contracts with certain agencies within the DoD, intelligence and civilian agencies.

Our selling model makes use of our field sales, engineering, product management, and executive personnel to establish and maintain customer contacts at multiple levels within a customer organization. We believe the successful execution of this multi-tiered selling model is important to our success.

Backlog

We manufacture our products based upon our forecast of customer demand and we typically build products in advance of receiving firm orders from our customers. Orders for net.com’s products are generally placed by customers on an as-needed basis and we typically have been able to ship these products within 30-90 days after the customer submits a firm purchase order. As a U.S.-based company, we are required to give priority to Federal Government rated “defense-expedite” (DX) orders, which may cause the backlog of other customers’ orders to become delinquent. Because of the possibility of customer changes in delivery schedules or cancellation of orders, net.com’s backlog as of any particular date may not be indicative of sales in any future period.

Customer Service

The markets, customers and complex challenges of the networking industry described above require not only hardware and software based solutions, but also support, service and other assistance in the development, operation and expansion of a customer network. Since our inception, we have viewed customer service and support as a key element of our overall strategy and a critical component of our long-term relationship with customers. Customers around the world turn to net.com not only for the reliability and performance of our products, but also for our comprehensive support services that optimize the value of those products. Customers rely on net.com to help maintain the highest possible availability of their mission-critical networks.

We provide a wide range of service and support options to customers and resellers of net.com products. Service offerings include product installation, a choice of different hardware and software maintenance programs to meet the varying needs of our customers, parts repair, remote and on-site technical assistance, and customer training. In addition, net.com provides web-based customer support services through our Electronic Support Center. Services available over the web include first-line troubleshooting information for net.com products; technical information, such as trouble shooting guides and frequently asked questions; and a web-based interface to net.com’s Technical Assistance Center (TAC) through an online case management system.

TAC is staffed 24 hours a day, seven days a week by engineers trained in networking products. TAC assists customers remotely over the telephone and has multiple language capabilities, including Spanish, Portuguese, Italian, Mandarin, French and German. TAC engineers have the ability to replicate customer problems and test proposed solutions prior to implementation. Maintenance support from TAC, whether provided over the web or over the telephone, is fee-based under either an annual fee contract or on a time-and-materials basis.

Customer training on net.com products, OEM products and the underlying technologies is provided to both end-users and resellers worldwide. We have training facilities at our Fremont, California, U.S. headquarters and in our facilities in Virginia, London, and Singapore. In addition, net.com trainers travel to customer and reseller facilities to provide training. Our training services can be customized to meet the special requirements of our customers. Customers are charged per person per class for net.com training. In addition, certain net.com resellers provide training to net.com end-users on behalf of net.com.

Historically, a significant amount of net.com’s revenue and profits have been generated by our service and support offerings. In fiscal 2004, 2003 and 2002, service and support offerings accounted for 14.9%, 16.5%, and 26.4%, respectively, of net.com’s revenue. Consistent with our business strategy, during fiscal 2001, we divested our Federal Services Business (FSB) and sold its assets to CACI International Inc. (CACI). The divestiture of our government services business to CACI allowed net.com to concentrate on the execution of our product strategies, and develop a good strategic alliance for our Federal business in CACI. We will continue to sell products directly to the Federal Government while CACI provides maintenance and other services to our Federal customers.

Manufacturing

We have one manufacturing facility located at our Fremont, California facility.  Manufacturing of subassemblies and parts including printed circuit boards are outsourced to Solectron Corporation (Solectron) and BreconRidge Manufacturing Solutions (BreconRidge). Final assembly, quality control and final testing are performed in the Fremont manufacturing facility. We maintain control over parts procurement, design, documentation and selection of approved suppliers. We have a multi-year contract with each of our contract manufacturers that require them to meet defined performance specifications.  Because Solectron and BreconRridge are sole source vendors for various product lines, any interruption in their manufacturing processes or a failure to renew their contracts could have a material adverse effect on our financial results and operations.

Currently, several key components of our Promina and SCREAM products are available only from a single source, including certain integrated circuits and power supplies. In addition, some components are in short supply generally throughout the industry. Depending upon the component, there may or may not be alternative sources or substitutes. Some of these components are purchased through purchase orders without an underlying long-term supply contract. Any delay or difficulty in obtaining needed components could seriously impact our ability to ship products.

We attempt to maintain sufficient inventory to ship products quickly, normally within 30 to 90 days after receipt of an order. Scheduling of production and inventory supply is based on internal sales forecasts. Generally, our customer contracts allow the customers to reschedule delivery dates or cancel orders within certain time frames before shipment without penalty and outside those time frames with a penalty. Because of these and other factors, there are risks of excess or inadequate inventory that could materially impact our expenses, revenue and earnings.

We are focused on continually enhancing the quality of products and services delivered to customers worldwide. This includes improving the quality of supplied components, subassemblies and internal processes. As part of this continuing process, net.com is ISO 9001:2000 certified.

As we achieve increased sales of our new products, we expect to obtain lower pricing on components purchased from our vendors and contract manufacturers as a result of higher purchase volume.

Research and Development

We believe that our long-term success depends on our ability to maintain product and technology leadership. The networking equipment industry is characterized by rapid technological change, evolving industry standards, frequent new product introductions, enhancements to products currently in the market and constantly changing customer requirements.  To compete effectively, net.com must be able to bring new products to market in a timely and cost-effective manner and enhance existing products to extend their useful lives.  Along with making continued investments in our internal research and development, we will also consider strategic acquisitions where appropriate to provide needed technology and resources.

We continually monitor relevant markets and our customers’ businesses and technology developments in order to develop products that proactively address customer needs. Our SCREAM products were designed with an open architecture to facilitate the development by third parties of products that will enhance the capabilities of SCREAM. Further, we design to industry standards and support industry standards bodies in their endeavors. Despite our efforts, however, there is no guarantee that we will be able to successfully develop new products or that our customers or our targeted markets will accept any products we develop.

The majority of our research and development activity is focused on broadband technologies, including the SCREAM product line. The development costs for SCREAM increased slightly in the most recent fiscal year as we worked to deliver the new SCREAM 3.0 platform with Cisco IOS, while overall development costs for SHOUTIP were relatively constant.  We continue to provide engineering support to Promina and to provide feature enhancements required to maintain Promina’s viability, and to invest in the SCREAMlink migration and TopSpin card enhancement programs. While most product development activity is undertaken in-house, external development organizations are sometimes used to accelerate or expand the scope of development efforts.

In fiscal 2004, 2003, and 2002, net.com’s research and development expenditures were $27.6 million, $26.0 million, and $33.0 million, respectively.

Employees

As of March 26, 2004, we had 410 full-time employees. None of our employees are represented by a labor union. We consider our employee relations to be good.

Geographic Information

See Note 14 to our consolidated financial statements.

Intellectual Property

We believe that the development of our intellectual property portfolio is central to our success and ability to compete effectively.  We devote considerable resources to invent and develop new technologies and then to protect these technologies from unauthorized use.  We have a program to seek protection of our proprietary technology under various protection frameworks such as patent, trade secret, trademarks and copyright protection.  We seek protection in the United States and in selected foreign countries where we believe filing for such protection is appropriate.  We believe that ownership of patents, trade secrets, trademarks and copyrights is central to our ability to defend ourselves against intellectual property infringement allegations.

We seek to protect our inventions, trade secrets and other confidential information by non-disclosure policies.  All of our employees and contractors sign confidentiality and invention disclosure agreements.  Any person outside net.com receiving net.com confidential information either signs a non-disclosure agreement prior to receiving proprietary technology information or is a net.com licensee.  We foster the disclosure of patentable inventions with a financial incentive program benefiting our employees and contractors.  

Over the past twenty years, a number of patents have been issued to net.com in the United States, Europe and Japan. These include some very early basic ATM inventions that conform to ATM Forum standards.  We have a highly focused effort to identify and patent our proprietary SCREAM and SHOUTIP technology and technology related to the migration of our narrowband Promina multiservice access platform to broadband services. In fiscal 2004 we filed 15 patent applications in the U.S. and were granted 3 U.S. patents.  We expect to continue filing patent applications as our development process for Promina, SCREAM and SHOUTIP moves forward. We have not historically pursued claims against other companies based on possible infringements of our patent portfolio, but we believe that our investment in intellectual property protection can offer defenses and bargaining positions in the event other companies pursue such claims against us. In June 2000, we entered into our first patent cross-licensing agreement.  The agreement is with Lucent Technologies, ARL Corporation (Lucent), whereby net.com and Lucent licensed patents to each other issued as of January 1, 2000 in any or all countries of the world. Specifically, Lucent received a license under all of our patents relating to our data networking products and/or our access system products and we will receive a license under all of Lucent’s patents relating to any and all of Lucent’s products and services. This cross-license agreement with Lucent has a five-year term and if not renewed will expire on December 31, 2004.

Where You Can Find More Information

We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to such reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act, available free of charge on or through our Internet website located at www.net.com, as soon as reasonably practicable after they are filed with or furnished to the SEC.  Stockholders may also access and download free of charge our corporate governance documents, including our Corporate Governance Guidelines, Audit Committee, Compensation Committee and Nominating/Corporate Governance Committee Charters, and Code of Business Conduct, on or through this Internet website.  In addition, any stockholder who wishes to obtain a print copy of any of these documents should write to:  Investor Relations, net.com, 6900 Paseo Padre Parkway, Fremont, California 94555-3660.

ITEM 2.  PROPERTIES

net.com is headquartered in Fremont, California.  In December 2000, we entered into a ten-year lease for two buildings totaling 185,790 square feet for our headquarters and research and development personnel as well as to house our manufacturing operations.  net.com and our subsidiaries also lease sales and service offices at other locations in the United States, Canada, United Kingdom, France, Mexico, Singapore, Uruguay, China, Japan, and Hong Kong.

ITEM 3.  LEGAL PROCEEDINGS

None.

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

No matters were submitted to a vote of the shareholders during the quarter ended March 26, 2004.

PART II

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

See Note 9 and 10 in the “Notes to Consolidated Financial Statements.”  At June 4, 2004, there were approximately 484 registered stockholders of record of net.com.  During the fiscal year ended March 26, 2004, there have been no issuer repurchases of equity securities.

Market Price

net.com’s common stock is traded on the New York Stock Exchange under the symbol “NWK.”  The following table sets forth, for the quarterly periods indicated, the high and low sale prices of our common stock:

net.com has never declared or paid dividends on our capital stock and does not intend to pay dividends in the foreseeable future.  In addition, our 7 ¼% convertible subordinated debentures trade in the over-the-counter market.

ITEM 6.  SELECTED FINANCIAL DATA

The following selected financial information has been derived from the audited consolidated financial statements.  The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes thereto included elsewhere in this Form 10-K.

(In thousands, except per share amounts)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying notes. Statements contained in this discussion that are not historical facts are forward-looking statements within the meaning of the federal securities laws that relate to future events or our future financial performance.  A forward-looking statement may contain words such as “plans,” “hopes,” “believes,” “estimates,” “will continue to be,” “will be,” “continue to,” “expect to,” “anticipate that,” “to be,” or “can impact.”  Forward-looking statements are based upon management expectations and involve risks and uncertainties that may cause actual results to differ materially from those anticipated in the forward-looking statements.  Many factors may cause actual results to vary including, bu t not limited to, the factors identified in this discussion.  net.com expressly disclaims any obligation or undertaking to revise or publicly release any updates or revisions to any forward-looking statement contained in this discussion.  Investors should carefully review the risk factors described in this document along with other documents net.com files from time to time with the Securities and Exchange Commission (SEC).

Significant Accounting Policy Judgments and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires that we make estimates and judgments, which affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to sales returns, bad debts, inventories, investments, intangible assets, income taxes, warranty obligations, restructuring charges, contingencies, such as litigation, and contract terms that have multiple elements and other complexities typical in the telecommunications equipment industry. We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition:  We enter into agreements to sell products and services and other arrangements (multiple element arrangements) that include combinations of products and services. We recognize product revenue generally upon shipment, when all four of the following criteria are met:

1)  we have a contract with our customer,
2)  when delivery has occurred and risk of loss passes to the customer,
3)  when our price is fixed or determinable, and
4)  when collection of the receivable is reasonably assured.

For transactions where we have not yet obtained customer acceptance, revenue is generally deferred until the terms of acceptance are satisfied. Revenue for installation or other services such as training is recognized upon completion of the service. Maintenance contract revenue is typically recognized ratably over the period of the contracts.  For arrangements that involve multiple elements, such as sales of products that include maintenance or installation services, revenue is allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element have been met.  We use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered at a future date and vendor specific objective evidence of the fair value of all the undelivered elements exists.  Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue.  If evidence of fair value of one or more undelivered elements does not exist, revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.

Allowance for Sales Returns:  A reserve for sales returns is established based on actual product returns. If the actual future returns differ from historical levels, our revenue could be adversely affected.

Allowance for Doubtful Accounts:  The allowance for doubtful accounts receivable is based on our assessment of the collectibility of specific customer accounts and the aging of accounts receivable. If there is a deterioration of a major customer’s credit worthiness or actual defaults are higher than our historical experience, we may have to increase our allowance for doubtful accounts receivable, and our operating expenses could be adversely affected.  Credit losses have historically been within our expectations and the allowances for doubtful accounts receivable that were established.

Inventory Provisions:   Inventory purchases and commitments are based upon future demand forecasts. If there is a significant decrease in demand for our products or there is a higher risk of inventory obsolescence because of rapidly changing technology and customer requirements, we may be required to make adjustments to write down our inventory to the lower of cost or market, and our gross margin could be adversely affected.

Warranty Accruals:   We generally provide a warranty for hardware product sales for twelve months and a warranty for software sales for three months. The software warranty entitles the customer to bug fixes but not software upgrades during the warranty period. We accrue warranty expense based on historical expense trends calculated as a percentage of new product sales.  Actual expenses are charged against the accrual in the period they are incurred. On a quarterly basis, the warranty accrual is analyzed for adequacy based on actual trends and subsequent adjustments are made to the liability balance.  If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required.  Historically, all warranty obligations have been determined with reasonable estimates.

Stock-Based Compensation:   We account for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretations.  Accordingly, no charges were taken during fiscal 2004 and 2003 as all stock options were granted at market price.

Deferred Taxes:   We have incurred tax losses in the last five fiscal years and, at March 26, 2004, we have an estimated $99.6 million of federal net operating loss carryforwards and $15.8 million of state operating loss carryforwards available expiring in the years 2020 through 2024.  We have provided a full valuation allowance against our deferred tax assets, given the uncertainty as to their realization. In future years, these benefits are available to reduce or eliminate taxes on future taxable income.  Current federal and state tax laws include provisions that could limit the annual use of our net operating loss carryforwards in the event of certain defined changes in stock ownership.  Our issuances of common and preferred stock could result in such a change.  Accordingly, the annual use of our net operating loss carryforwards may be limited by these provisions, and this limitation may result i n the loss of carryforward benefits to the extent the above-limit portion expires before it can be used.  Management has not yet determined the extent of the limitation, if any.

Results of Operations

The following table depicts selected data derived from our consolidated condensed statements of operations expressed as a percentage of revenue for the periods presented:

Overview and Highlights

       ●  We are focused on achieving profitability. In the year ended March 26, 2004, we were nearly breakeven with a net loss of $559,000.  This loss compares to an $18.4 million loss in fiscal 2003 and a $37.4 million loss in fiscal 2002.

       ●  The primary driver for profitability is growing our revenue base. Total revenue for the year ended March 26, 2004 increased $4.9 million or 4.0% from the year ended March 28, 2003, which increased $20.6 million or 20.2% from the year ended March 29, 2002. The increases in total revenue were due to increases in product revenue partially offset by decreases in service and other revenue.

       ●  In order to grow revenue, we must develop and successfully introduce new products. During the year ended March 26, 2004, we announced a number of new product releases incorporating significant product developments, including: the addition of Cisco’s IOS software to our SCREAM platform; enhancements for secure voice on our SHOUTIP platform; new versions of a number of cards for our Promina platform with enhanced functionality as well as production cost savings; and our new network management system, netMS. Revenue from our new products, SCREAM, SHOUTIP and netMS, was $10.5 million for the year ended March 26, 2004.  New product revenue for fiscal years ended March 28, 2003 and March 29, 2002 was less than 10% of total product revenue.

       ●  Until our new products achieve broad market acceptance, we are dependent on revenue from existing products. To date, we have been successful in extending the lifecycle of our circuit-switched products by continually expanding their functionality, and we have developed a migration path to broadband technology through the SCREAMlink program. The SCREAMlink program, which facilitates the connection of our circuit-switched Promina products to our broadband SCREAM products, has helped stimulate demand for both product lines. The Promina product line continues to provide the substantial majority of our revenue, and in the year ended March 26, 2004, we received substantial new orders for Promina products, particularly from defense agencies, including a large order comprised of Promina, SCREAMlink and SCREAM gear for integrated voice, routin g, and data transport capabilities over a variety of transport protocols.

       ●  Our new products are targeted primarily at telecommunications carriers, and also at new applications within our existing customer base. The environment for sales of new equipment to telecommunications carriers remains challenging, but we believe that some carriers are beginning to resume investment in new equipment, which may result in increased sales opportunities for our new products. In the year ended March 26, 2004, the SCREAM platform was tested in a number of carriers’ testing labs.  We also installed a new SHOUTIP network for an existing customer to deliver VoIP.  We tested SHOUTIP for defense customers, and sold SHOUTIP to the United States Central Command (Centcom), for a secure VoIP application.

       ●  We strive to maintain a strong cash position for stability and flexibility in managing our business. Total cash, cash equivalents, restricted cash and short term investments at March 26, 2004 rose to $102.0 million, including $2.3 million in long term restricted cash related to performance guarantees on customer contracts and our facilities leases in Fremont, California. This compares to $94.6 million at March 28, 2003 and $94.9 million at March 29, 2002.  The increase in cash resulted from operating activities and proceeds from the sale of common stock upon the exercise of employee stock options.

Revenue