NETWORK EQUIPMENT TECHNOLOGIES INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)

Quarterly Report Pursuant to Section 13 or 15(D) of the Securities Exchange Act of 1934
For the quarterly period ended September 24, 2004

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)

Delaware
(State or other jurisdiction of
incorporation or organization)

94-2904044
(I.R.S. Employer
Identification Number)

6900 Paseo Padre Parkway
Fremont, CA 94555-3660
(510) 713-7300

(Address, including zip code, and telephone number
including area code, of registrant's principal executive offices)

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. x Yes ¨ No

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

The number of shares outstanding of the registrant's Common Stock, par value $.01, as of October 22, 2004 was 24,484,238.

NETWORK EQUIPMENT TECHNOLOGIES, INC.

INDEX

			Page Number
PART I. FINANCIAL INFORMATION

	Item 1. Financial Statements		3

		Condensed Consolidated Balance Sheets at September 24, 2004 and March 26, 2004	3

		Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) – Quarter and six months ended September 24, 2004 and September 26, 2003	4

		Condensed Consolidated Statements of Cash Flows – Six months ended September 24, 2004 and September 26, 2003	5

		Notes to Condensed Consolidated Financial Statements	6

	Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition		10

	Item 3. Quantitative and Qualitative Disclosures about Market Risk		24

	Item 4. Controls and Procedures		25

PART II. OTHER INFORMATION

	Item 1. Legal Proceedings		25

	Item 4. Submission of Matters to a Vote of Security Holders		26

	Item 6. Exhibits		26

SIGNATURES			27

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Balance Sheets
(Unaudited -- in thousands, except par value)

		September 24, 2004			March 26, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	9,096		$	12,174
Restricted cash		549			847
Short-term investments		89,861			86,711
Accounts receivable, net of allowance for doubtful accounts and sales returns of $166 at September 24, 2004 and $240 at March 26, 2004		24,214			19,709
Inventories		12,709			13,665
Prepaid expenses and other assets		2,755			2,898
Total current assets		139,184			136,004
Property and equipment, net		29,715			31,423
Other assets		4,390			4,657
Total assets	$	173,289		$	172,084

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	6,290		$	6,334
Accrued liabilities		15,705			15,681
Total current liabilities		21,995			22,015
Long-term liabilities:
7 1/4% redeemable convertible subordinated debentures		24,706			24,706
Other long-term liabilities		1,518			1,705
Total long-term liabilities		26,224			26,411
Stockholders' equity:
Preferred stock ($0.01 par value; 5,000 shares authorized; none outstanding)		-			-
Common stock ($0.01 par value; 50,000 shares authorized; 24,453 and 24,165 shares outstanding at September 24, 2004 and March 26, 2004, respectively)		244			241
Additional paid-in capital		194,602			193,093
Treasury stock		(3,408	)		(3,408	)
Accumulated other comprehensive income (loss)		(462	)		199
Accumulated deficit		(65,906	)		(66,467	)
Total stockholders' equity		125,070			123,658
Total liabilities and stockholders' equity	$	173,289		$	172,084

See accompanying notes to condensed consolidated financial statements

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
(Unaudited -- in thousands, except per share amounts)

	Quarter Ended						Six Months Ended
	September 24, 2004			September 26, 2003			September 24, 2004			September 26, 2003
Revenue:
Product	$	27,461		$	27,776		$	51,854		$	57,073
Service and other		4,135			4,164			8,839			8,968
Total revenue		31,596			31,940			60,693			66,041
Costs of sales:
Cost of product revenue		10,120			11,013			19,190			23,367
Cost of service and other revenue		4,317			3,607			8,330			7,565
Total cost of sales		14,437			14,620			27,520			30,932
Gross margin		17,159			17,320			33,173			35,109
Operating expenses:
Sales and marketing		6,816			7,264			14,551			15,118
Research and development		7,088			6,949			13,941			13,789
General and administrative		2,442			2,442			5,109			5,190
Restructure costs (benefit)		(103	)		-			1,271			266
Total operating expenses		16,243			16,655			34,872			34,363
Income (loss) from operations		916			665			(1,699	)		746
Interest income		405			327			800			744
Interest expense		(504	)		(524	)		(1,003	)		(1,034	)
Gain on sale of Federal Services Business		-			-			1,500			1,500
Other income (expense)		(26	)		(68	)		(157	)		19
Income (loss) before taxes		791			400			(559	)		1,975
Income tax benefit		(599	)		-			(1,120	)		(15	)
Net income	$	1,390		$	400		$	561		$	1,990

Per share data:
Net income:
Basic	$	0.06		$	0.02		$	0.02		$	0.09
Diluted	$	0.06		$	0.02		$	0.02		$	0.08
Common and common equivalent shares:
Basic		24,343			23,066			24,286			22,939
Diluted		25,070			24,342			24,650			24,136
Consolidated Statements of Comprehensive Income (Loss):
Net income	$	1,390		$	400		$	561		$	1,990
Other comprehensive income, net of tax:
Cumulative translation adjustments		(94	)		(181	)		(39	)		73
Net unrealized gain (loss) on securities		256			(160	)		(622	)		(145	)
Comprehensive income (loss)	$	1,552		$	59		$	(100	)	$	1,918

See accompanying notes to condensed consolidated financial statements

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited -- in thousands)

	Six Months Ended
	September 24, 2004			September 26, 2003
Cash and cash equivalents at beginning of period	$	12,174		$	20,593
Cash flows from operating activities:
Net income		561			1,990
Adjustments required to reconcile net income to net cash used in operating activities:
Depreciation and amortization		4,424			4,407
Gain on sale of Federal Services Business		(1,500	)		(1,500	)
Loss on disposition of property and equipment		41			74
Changes in assets and liabilities:
Accounts receivable		(4,505	)		(10,696	)
Inventories		956			2,650
Prepaid expenses and other assets		143			(358	)
Accounts payable		(44	)		3,693
Accrued liabilities		(163	)		(1,916	)
Net cash used in operating activities		(87	)		(1,656	)
Cash flows from investing activities:
Purchases of short-term investments		(43,813	)		(134,302	)
Proceeds from maturities of short-term investments		40,041			122,686
Purchases of property and equipment		(2,479	)		(3,297	)
Proceeds from sale of Federal Services Business		1,500			1,500
Change in restricted cash		298			1
Other, net		(11	)		226
Net cash used in investing activities		(4,464	)		(13,186	)
Cash flows from financing activities:
Issuance of common stock		1,511			2,997
Net cash provided by financing activities		1,511			2,997
Effect of exchange rate changes on cash		(38	)		170
Net decrease in cash and cash equivalents		(3,078	)		(11,675	)
Cash and cash equivalents at end of period	$	9,096		$	8,918
Other cash flow information:
Cash paid during the year for:
Interest	$	987		$	987
Income taxes	$	13		$	28
Non-cash investing and financing activities:
Unrealized loss on available-for-sale securities	$	(622	)	$	(145	)

See accompanying notes to the condensed consolidated financial statements

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements

Note 1. Description of the Company

Network Equipment Technologies, Inc., doing business as net.com (net.com or the Company), is a global provider of networking technology platforms that are used for mission-critical communications solutions. The Company's multiservice wide area networking (WAN) products, comprising the Promina product line, use circuit-switched technology to provide an effective platform for developing reliable and secure networks. In response to the growth of next-generation networks using packet-switching technologies and the Internet protocol (IP), the Company developed its SCREAM and SHOUTIP platforms for broadband services, IP telephony, and multiservice networks. These platforms allow network service providers to rapidly create and deliver new service offerings that the Company believes can help them to accelerate the return on their network investment, reduce capital and operating expenditures, and achieve greater profits. Network Equipment Technologies, In c. was founded in 1983 and has been doing business as net.com since 2000.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation: The condensed consolidated financial statements include the accounts of net.com and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) considered necessary to present fairly the financial position as of September 24, 2004, the results of operations for the quarter and six months ended September 24, 2004 and September 26, 2003, and the cash flows for the six months ended September 24, 2004 and September 26, 2003. These financial statements should be read in conjunction with the March 26, 2004 audited consolidated financial statements and notes thereto. The results of operations for the quarter and six months ended September 24, 2004 are not necessarily indicative of the results to be expected for the fiscal year ending March 25, 2005.

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

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

For transactions where the Company has not yet obtained customer acceptance, revenue is generally deferred until the terms of acceptance are satisfied. For transactions where product revenue has been deferred, the Company defers the associated cost of goods until the product revenue is recognized. 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 contract. 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. The Company uses 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 ev idence 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, revenue could be adversely affected.

Stock-Based Compensation: net.com accounts for its 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. Stock-based compensation related to non-employees is based on the fair value of the related stock or options in accordance with Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock Based Compensation. Expense associated with stock-based compensation is amortized on an accelerated basis under Financial Accounting Standards Board Interpretation (FIN) No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, over the vesting period of each individual award. In accordance with SFAS No. 148, Accounting for Stock-Based Compensation--Transition and Disclosures--an amendment to FASB Statement No. 123, the Company is required to disclose the effects on reported net income (loss) and basic and diluted net income (loss) per share as if the fair value based method had been applied to all awards. For the quarters and six months ended September 24, 2004 and September 26, 2003, had compensation cost been determined based on the fair value method pursuant to SFAS 123, the Company’s net income would have been as follows (in thousands, except per share amounts):

		Quarter Ended						Six Months Ended
	September 24, 2004			September 26, 2003			September 24, 2004			September 26, 2003
Net income – as reported	$	1,390		$	400		$	561		$	1,990
Less: Stock-based compensation expense determined by the fair value method, net of tax		(967	)		(1,119	)		(1,720	)		(2,268	)
Net income (loss) – pro forma	$	423		$	(719	)	$	(1,159	)	$	(278	)

Basic income per share – as reported	$	0.06		$	0.02		$	0.02		$	0.09
Diluted income per share – as reported	$	0.06		$	0.02		$	0.02		$	0.08

Basic income (loss) per share – pro forma	$	0.02		$	(0.03	)	$	(0.05	)	$	(0.01	)
Diluted income (loss) per share – pro forma	$	0.02		$	(0.03	)	$	(0.05	)	$	(0.01	)

Allowance for Doubtful Accounts: The allowance for doubtful accounts receivable is based on an 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 historical experience, the Company may have to increase the allowance for doubtful accounts receivable, and operating expenses could be adversely affected. Credit losses have historically been within the expectations and 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 certain products or there is a higher risk of inventory obsolescence because of rapidly changing technology and customer requirements, adjustments may be required to write down the inventory to the lower of cost or market, which would adversely affect gross margin.

Deferred Taxes: The Company has incurred tax losses in the last five fiscal years and, at September 24, 2004, has an estimated $101.3 million of federal net operating loss carryforwards available that expire in the years 2020 through 2025 and $18.9 million of state operating loss carryforwards available, expiring in the years 2007 through 2015. A full valuation allowance against deferred tax assets has been provided, 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 the net operating loss carryforwards in the event of certain defined changes in stock ownership. Issuances of common and preferred stock could result in such a change. Accordingly, the annual use of the net operating loss carryforwards may be limited by these provisions, and this limitation may result in the loss of carryforward benefits to the extent the above-limit portion expires before it can be used. The Company has not yet determined the extent of the limitation, if any.

Recently Issued Accounting Standards: In December 2003, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition. SAB 104 revises or rescinds portions of the interpretive guidance included in Topic 13 of the codification of staff accounting bulletins in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The adoption of SAB 104 did not have a material effect on the Company’s results of operations or financial condition.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which requires that certain financial instruments be presented as liabilities that were previously presented as equity or as temporary equity. Such instruments include mandatorily redeemable preferred and common stock, and certain options and warrants. SFA