NETWORK EQUIPMENT TECHNOLOGIES INC - FORM 10-Q - August 2, 2011

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

FORM 10-Q

(Mark One)

x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 24, 2011.

OR

¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ___________________ to ___________________.

Commission File Number 001-10255

NETWORK EQUIPMENT TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State of incorporation)
94-2904044
(I.R.S. Employer Identification Number)

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

(Address of principal executive offices, including zip code, and telephone number)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
¨ Yes  ¨ No  (Not applicable)

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
Accelerated filer x
Non-accelerated filer ¨
Smaller reporting company ¨

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

The number of shares outstanding of the registrant's Common Stock, par value $0.01, as of July 22, 2011 was 30,397,000.
 
 
 
 

NETWORK EQUIPMENT TECHNOLOGIES, INC.

PART I.  FINANCIAL INFORMATION
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PART II.  OTHER INFORMATION
  
     
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2

PART I - FINANCIAL INFORMATION


NETWORK EQUIPMENT TECHNOLOGIES, INC.
(Unaudited — in thousands, except par value)

   
June
24, 2011
    
March
25, 2011
  
Current assets:
            
Cash and cash equivalents
   $ 5,080     $ 2,367  
Short-term investments
     46,790       56,860  
Restricted cash
     2,192       2,192  
Accounts receivable, net of allowances of $251 at June 24, 2011 and $234 at March 25, 2011
     7,368       8,701  
Inventories
     4,917       4,660  
Prepaid expenses and other assets
     5,110       5,860  
Total current assets
     71,457       80,640  
Property and equipment, net
     4,152       4,435  
Other assets
     4,023       4,296  
Total assets
   $ 79,632     $ 89,371  
                 
Current liabilities:
                
Accounts payable
   $ 4,633     $ 5,496  
Accrued liabilities
     8,551       10,262  
Total current liabilities
     13,184       15,758  
                 
Long-term liabilities:
                
3¾% convertible senior notes
     10,500       10,500  
7¼% redeemable convertible subordinated debentures
     23,704       23,704  
Capital lease obligation, less current portion
     115       137  
Other long-term liabilities
     1,495       1,097  
Total long-term liabilities
     35,814       35,438  
                 
Commitments and contingencies – See Note 7
                
Stockholders’ equity:
                
Preferred stock ($0.01 par value; 5,000 shares authorized; none outstanding)
     —       —  
Common stock ($0.01 par value; 75,000 shares authorized; 30,397 and 30,389 shares outstanding at June 24, 2011 and March 25, 2011)
     303       303  
Additional paid-in capital
     259,204       258,339  
Treasury stock, at cost
     (11,645 )     (11,532 )
Accumulated other comprehensive loss
     (1,981 )     (2,108 )
Accumulated deficit
     (215,247 )     (206,827 )
Total stockholders’ equity
     30,634       38,175  
Total liabilities and stockholders’ equity
   $ 79,632     $ 89,371  

See accompanying notes to condensed consolidated financial statements

 
3

NETWORK EQUIPMENT TECHNOLOGIES, INC.
(Unaudited — in thousands, except per share amounts)

   
Three Months Ended
  
   
June
24, 2011
    
June
25, 2010
  
Revenue:
            
Product
   $ 7,699     $ 9,987  
Service and other
     3,614       3,494  
Total revenue
     11,313       13,481  
Costs of revenue:
                
Cost of product
     5,353       5,622  
Cost of service and other
     2,112       3,111  
Total cost of revenue
     7,465       8,733  
Gross margin
     3,848       4,748  
Operating expenses:
                
Sales and marketing
     4,464       4,733  
Research and development
     4,821       5,039  
General and administrative
     2,498       2,726  
Total operating expenses
     11,783       12,498  
Loss from operations
     (7,935 )     (7,750 )
Interest income
     106       224  
Interest expense
     (553 )     (552 )
Other income (expense), net
     34       (81 )
Loss before taxes
     (8,348 )     (8,159 )
Income tax provision
     72       51  
Net loss
   $ (8,420 )   $ (8,210 )
Basic and diluted net loss per share
   $ (0.28 )   $ (0.28 )
Common and common equivalent shares, basic and diluted
     30,316       29,634  
Condensed Consolidated Statements of Comprehensive Loss:
                
Net loss
   $ (8,420 )   $ (8,210 )
Other comprehensive loss:
                
Foreign currency translation adjustments
     83       (94 )
Gross unrealized holding gains (losses) on available-for-sale securities
     80       (46 )
Less: Reclassification adjustments for gains included in net loss
     (36 )     (70 )
Comprehensive loss
   $ (8,293 )   $ (8,420 )

See accompanying notes to condensed consolidated financial statements

 
4

NETWORK EQUIPMENT TECHNOLOGIES, INC.
(Unaudited — in thousands)

   
Three Months Ended
  
   
June
24, 2011
    
June
25, 2010
  
Cash and cash equivalents at beginning of period
   $ 2,367     $ 4,953  
Cash flows from operating activities:
                
Net loss
     (8,420 )     (8,210 )
Adjustments required to reconcile net loss to net cash used in operating activities:
                
Depreciation, amortization, and accretion
     560       680  
Stock-based compensation expense
     883       1,447  
Loss on disposition of property and equipment
     —       3  
Provision for deferred income taxes
     62       —  
Changes in assets and liabilities:
                
Accounts receivable
     1,333       3,594  
Inventories
     (257 )     182  
Prepaid expenses and other assets
     885       1,805  
Accounts payable
     (862 )     (1,645 )
Accrued liabilities
     (1,315 )     (2,351 )
Net cash used in operating activities
     (7,131 )     (4,495 )
Cash flows from investing activities:
                
Purchase of short-term investments
     (5,385 )     (14,842 )
Proceeds from sales and maturities of short-term investments
     15,499       18,454  
Purchases of property and equipment
     (204 )     (394 )
Net cash provided by investing activities
     9,910       3,218  
Cash flows from financing activities:
                
Issuance of common stock
     1       42  
Repurchase of common stock
     (113 )     (328 )
Payments under capital lease and note payable obligations
     (33 )     (14 )
Net cash used in financing activities
     (145 )     (300 )
Effect of exchange rate changes on cash
     79       (70 )
Net increase (decrease) in cash and cash equivalents
     2,713       (1,647 )
Cash and cash equivalents at end of period
   $ 5,080     $ 3,306  
                 
Other cash flow information:
                
Cash paid during the period for:
                
Interest
   $ 1,060     $ 1,056  
Non-cash investing activities:
                
Net unrealized gain (loss) on available-for-sale securities
     44       (116 )

See accompanying notes to condensed consolidated financial statements

 
5

NETWORK EQUIPMENT TECHNOLOGIES, INC.

Note 1.  Description of Business and Summary of Significant Accounting Policies

Nature of Business:  Network Equipment Technologies, Inc. (the Company or NET) provides network and VoIP solutions to enterprises and government agencies that seek to reduce the cost to deploy next generation unified and secure communications applications. For over a quarter of a century, NET has delivered solutions for multi-service networks requiring high degrees of versatility, security and performance. Today, the Company’s broad family of products enables interoperability and integration with existing networks for migration to secure IP-based communications. Broadening NET’s voice solutions, Quintum Technologies (Quintum), now a part of NET, is a VoIP innovator whose applications bring the reliability and clarity of public telephone networks to Internet telephony and unified communications. NET was founded in 1983.

Significant Accounting Policies:  The unaudited condensed consolidated financial statements of the Company included herein have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The condensed consolidated balance sheet as of March 25, 2011 was derived from the Company’s audited consolidated financial statements.

These financial statements should be read in conjunction with the March 25, 2011 audited consolidated financial statements and notes thereto. The results of operations for the three months ended June 24, 2011 are not necessarily indicative of the results to be expected for the fiscal year ending March 30, 2012 or any future period.

The Company’s fiscal year ends on the last Friday in March. In most years, the fiscal year is 52 weeks, with each quarter comprised of thirteen weeks, which allows comparability of quarter over quarter results. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) considered necessary to present fairly the financial position as of June 24, 2011, the results of operations for the three months ended June 24, 2011 and June 25, 2010, respectively and the cash flows for the three months ended June 24, 2011 and June 25, 2010, respectively.
 
Revenue Recognition:  The Company derives revenue primarily from the sales of hardware, software, services, post-contract support (PCS), and professional services. PCS typically includes unspecified software updates and upgrades on an if-and-when available basis and telephone and internet access to technical support personnel.

In October 2009, the Financial Accounting Standards Board (FASB) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance. In October 2009, the FASB also amended the standards for multiple deliverable revenue arrangements to:

 
(i)
provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the arrangement consideration should be allocated among its elements;

 
(ii)
require an entity to allocate the revenue using estimated selling prices (ESP) of the deliverables if there is no vendor specific objective evidence (VSOE) or third party evidence of selling price (TPE); and

 
(iii)
eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

This new accounting guidance became applicable to the Company beginning the first quarter of its fiscal 2012. The Company adopted this guidance for transactions that were entered into or materially modified on or after March 26, 2011 using the prospective basis of adoption.

Product revenue is recognized when the Company has a contract with its customer, the product has been shipped as required by the contract and risk of loss has passed to its customer, the price is fixed or determinable, and the collectability of the related receivable is probable. If the customer has a right of acceptance and the Company has not yet obtained acceptance, revenue is deferred until the terms of acceptance are satisfied. When product revenue is deferred, the Company also defers the associated cost of goods until the revenue is recognized. The Company recognizes service revenue upon completion of the service or, for ongoing services such as PCS, ratably over the period of the contract.

Revenue on sales through resellers is recognized upon transfer of title to the reseller. Many of the sales to the Company’s resellers are based upon firm commitments from their end customer; as a result, these resellers carry little or no NET stock. For the Company’s Promina, VX, NX and UX products, NET’s customers generally do not have the right to return the equipment. For the Company’s Quintum product line, NET customers are subject to agreements allowing for limited rights of return and price protection. Accordingly, revenues are reduced for the Company’s estimates of liability related to these rights. The estimate for returns is recorded at the time the related sale is recognized and is adjusted periodically based on historical rates of returns and other related factors. The reserves for price protection are recorded at the time these programs are offered. Price protection is estimated based on specific programs, expected usage and historical experience.
 
 
6

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(continued)
 
The new revenue recognition guidance does not generally change the units of accounting for the Company’s revenue transactions. All of the products and services continue to qualify as separate units of accounting. The Company analyzes all of its products, software and services and considers the features and functionalities of the individual elements and the stand-alone sales of those individual components among other factors, to determine which elements are essential or non-essential to the overall functionality of the networking equipment. The Company’s core software (herein after referred to as ‘essential software’) is integrated with hardware and is essential to the functionality of the networking equipment. The Company’s sale of additional software provides increased features and functions, but is not essential to the overall functionality of the networking equipment (herein after referred to as ‘non-essential software’).

For transactions entered into prior to the first quarter of fiscal 2012, the Company recognized revenue based on ASC 985-605 (formerly referred to as SOP No. 97-2, Software Revenue Recognition). In accordance with ASC 985-605, the Company utilized the residual method to determine the amount of product revenue to be recognized. Under the residual method, the fair value of the undelivered elements, such as PCS, is deferred and the remaining portion of the arrangement consideration is recognized as product revenue. VSOE of fair value is limited to the price charged when the same element is sold separately. VSOE of fair value is established for PCS and professional services based on the volume and pricing of the stand-alone sales within a narrow range. The fair value of the post-contractual support is recognized on a straight-line basis over the term of the related support period, which is typically one month to three years.

For transactions entered into or materially modified on or after the beginning of the first quarter of fiscal 2012, the total arrangement fees were allocated to all the deliverables based on their respective relative selling prices. The relative selling price is determined using VSOE when available. When VSOE cannot be established, the Company attempts to determine the TPE for the deliverables. TPE is determined based on competitor prices for similar deliverables when sold separately by the competitors. Generally the Company’s product offerings differ from those of its competitors and comparable pricing of its competitors is often not available. Therefore, the Company is typically not able to determine TPE. When the Company is unable to establish selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement fees. The ESP for a deliverable is determined as the price at which the Company would transact if the products or services were sold on a stand-alone basis.

The Company has been able to establish VSOE for its PCS and professional services based on the volume and the pricing of the stand-alone sales for these services within a narrow range.

The Company has determined the ESP of its products and services for which VSOE has not been established based on an analysis of (i) the list price, which represents a component of the Company’s current go-to market strategy, as established by senior management taking into consideration factors such as geography and the competitive and economic environment and (ii) an analysis of the historical pricing with respect to both the Company’s bundled and stand-alone sales of each product or service.

The Company’s multiple element arrangements may include non-essential software deliverables that are subject to the industry specific software revenue recognition guidance. The revenue for these multiple element arrangements is allocated to the non-essential software deliverables and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the new revenue accounting guidance. As the Company has not been able to obtain VSOE for all of the non-essential software deliverables in the arrangement, revenue allocated to such non-essential software elements is recognized using the residual method in accordance with industry specific software revenue recognition guidance as the Company was able to obtain VSOE for the undelivered elements bundled with such non-essential software elements. Under the residual method, the amount of revenue recognized for the delivered non-essential software elements equaled the total allocated consideration less the VSOE of any undelivered elements bundled with such non-essential software elements.

The change from the residual to the relative selling price method did not have a material impact on the allocation of revenue to the arrangement deliverables, nor did the Company change its assessment of the deliverables contained within its revenue arrangements. The adoption of the new revenue accounting guidance was not material to the Company’s financial results for the three months ended June 24, 2011.
 
Recently Issued Accounting Standards:   In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (“ASU”) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the FASB Accounting Standards CodificationTM (Codification) to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The Company will adopt this new guidance on the mandatory adoption date of March 31, 2012, the beginning of the Company’s fiscal 2013. We do not anticipate the adoption of this ASU will have any effect upon the Company’s consolidated financial statements.

In May 2011, FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The Company will adopt this new guidance, on a prospective basis, on the mandatory adoption date of March 31, 2012, the beginning of the Company’s fiscal 2013. We do not anticipate the adoption of this ASU will have a material effect upon the Company’s consolidated financial statements.

In January 2010, the FASB issued new accounting guidance to amend and clarify existing guidance related to fair value measurements and disclosures: ASU No. 2010-06 — Improving Disclosures about Fair Value Measurements. This guidance requires entities to separately present purchases, sales, issuances, and settlements in their reconciliation of Level 3 fair value measurements (i.e., to present such items on a gross basis rather than on a net basis), and clarifies existing disclosure requirements regarding the level of disaggregation and the inputs and valuation techniques used to measure fair value for measurements that fall within either Level 2 or Level 3 of the fair value hierarchy. The Company adopted the provisions of this guidance effective March 27, 2010, except for the requirement to disclose purchases, sales, issuances, and settlements related to Level 3 measurements, which the Company adopted on March 26, 2011, the beginning of the Company’s fiscal 2012.

The adoption of ASU 2010-16 was not material to the Company’s financial results for the three months ended June 24, 2011.

 
7

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(continued)
 
Note 2.  Financial Instruments

Short-term investments at June 24, 2011 and March 25, 2011 consisted of the following:

(in thousands)
 
 
  
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Fair
Value
  
June 24, 2011
                        
U.S. Treasury notes
   $ 5,302     $ 13     $ (2 )   $ 5,313  
U.S. government agencies
     12,625       55       —       12,680  
Corporate notes and bonds
     16,502       56       (2 )     16,556  
Asset backed securities
     10,683       46       (4 )     10,725  
Other debt securities
     1,510       6       —       1,516  
    $ 46,622     $ 176     $ (8 )   $ 46,790  
March 25, 2011
                                
U.S. Treasury notes
   $ 3,222     $ 10     $ (1 )   $ 3,231  
U.S. government agencies
     17,297       34       (15 )     17,316  
Corporate notes and bonds
     20,507       66       (13 )     20,560  
Asset backed securities
     14,187       61       (21 )     14,227  
Other debt securities
     1,523       4       (1 )     1,526  
    $ 56,736     $ 175     $ (51 )   $ 56,860  

The maturities of short-term investments at June 24, 2011 are as follows:

(in thousands)
  
Amortized
Cost
    
Estimated
Market Value
  
Maturing in one year
   $ 16,149     $ 16,205  
Maturing in one to five years
     30,473       30,585  
Total
   $ 46,622     $ 46,790  

The following table summarizes the financial assets and liabilities of the Company measured at fair value on a recurring basis:

(in thousands)
        
Fair Value Measurements at
 June 24, 2011, using
  
   
Balance as of
             
   
June 24, 2011
    
Level 1
    
Level 2
  
Assets:
                  
U.S. Treasury notes(1)
   $ 5,313     $ 5,313     $ —  
U.S. government agencies(1)
     12,680       —       12,680  
Corporate notes and bonds(1)
     16,556       —       16,556  
Asset backed securities(1)
     10,725       —       10,725  
Foreign debt issues(1)
     1,516       —       1,516  
      46,790       5,313       41,477  
Foreign currency derivatives(2)
     45       —       45  
Total
   $ 46,835     $ 5,313     $ 41,522  
                         
Liabilities:
                        
Foreign currency derivatives(3)
   $ 61     $ —     $ 61  
Total
   $ 61     $ —     $ 61  

(in thousands)
        
Fair Value Measurements at
 March 25, 2011, using
  
    Balance as of              
   
March 25, 2011
    
Level 1
    
Level 2
  
Assets:
                  
U.S. Treasury notes(1)
   $ 3,231     $ 3,231     $ —  
U.S. government agencies(1)
     17,316       —       17,316  
Corporate notes and bonds(1)
     20,560       —       20,560  
Asset backed securities(1)
     14,227       —       14,227  
Foreign debt issues(1)
     1,526       —       1,526  
      56,860       3,231       53,629  
Foreign currency derivatives(2)
     31       —       31  
Total
   $ 56,891     $ 3,231     $ 53,660  
                         
Liabilities:
                        
Foreign currency derivatives(3)
   $ 112     $ —     $ 112  
Total
   $ 112     $ —     $ 112  

 
(1)
Included in short-term investments on the Company’s condensed consolidated balance sheet.
 
(2)
Included in accounts receivable on the Company’s condensed consolidated balance sheet.
 
(3)
Included in accrued liabilities on the Company’s condensed consolidated balance sheet.

 
8

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(continued)
 
The three levels of the fair value hierarchy are:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Observable inputs other than quoted prices included within Level 1, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs other than quoted prices that are observable or are derived principally from, or corroborated by, observable market data by correlation or other means.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Derivative financial instruments are limited to foreign exchange contracts which the Company enters into to hedge certain balance sheet exposures and intercompany balances against future movement in foreign exchange rates. The Company’s primary net foreign currency exposures are in Japanese yen, Euros, and British pounds. The fair value of the Company’s derivative instruments is determined using pricing models based on current market rates. Gains and losses on foreign exchange contracts are included in other income and expense, net, and were not material for any period presented.

Note 3. Inventories

Inventories consisted of the following:

(in thousands)
  
June
24, 2011
    
March
25, 2011
  
Purchased components
   $ 3,339     $ 3,037  
Finished goods
     1,578       1,623  
    $ 4,917     $ 4,660  

Certain inventories, not expected to be consumed within the next 12 months, are included in the condensed consolidated balance sheet as non-current assets. These inventories were $681,000 and $805,000, respectively, at June 24, 2011 and March 25, 2011.

Under the Company’s agreement with its primary contract manufacturer, Plexus Corp. (Plexus), which runs through December 31, 2011, the Company maintains a level of control over parts procurement, design, documentation, and selection of approved suppliers. The Company is generally liable for any termination or cancellation of product orders, as well as excess and obsolete material, which can result, for example, from an engineering change, product obsolescence, or inaccurate component forecasting. Under the agreement, Plexus is to procure raw materials and begin manufacturing of products in accordance with the Company’s forecasts. If certain purchased raw materials or certain work-in-process items are held for greater than 90 days, the Company must make deposits on the aging inventory, although Plexus must make efforts to minimize the Company’s liability for the aging inventory, including returning materials to suppliers, canceling orders with suppliers, or using materials to manufacture product for its other customers. If raw material or in-process inventories are still unused and have been held for more than nine months, the Company must take ownership and pay for the aged inventory. Alternatively, if there is forecasted demand for such inventory, the Company must pay a management fee for Plexus to retain such inventory. If the forecasted demand does not materialize the Company must take ownership and pay for such inventory. This activity may increase the Company’s owned inventories.

At June 24, 2011, the Company’s deposit on inventory held by Plexus was $3.8 million, of which $1.2 million had been charged to a reserve for excess inventory. The deposit, including the related reserve, is included in prepaid expenses and other assets in the condensed consolidated balance sheets.

The Company regularly evaluates its inventory for lower of cost or market valuation, including inventory held by Plexus and the amount on deposit with Plexus as well as inventory classified as non-current assets. As a result of these evaluations, the Company recorded charges of $247,000 and $291,000, respectively, to cost of revenue in the three months ended June 24, 2011 and June 25, 2010.

 
9

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(continued)
 
Note 4.  Loss Per Share

The following table sets forth the computation of the numerator and denominator used in the computation of basic and diluted net loss per share:

(in thousands, except per share amounts)
  
Three Months Ended
  
   
June
24, 2011
    
June
 25, 2010
  
Numerator:
            
Net loss
   $ (8,420 )   $ (8,210 )
Denominator-weighted average shares of common stock outstanding:
                
Shares used to compute basic and diluted  net loss per share
     30,316       29,634  
Basic and diluted net loss per share
   $ (0.28 )   $ (0.28 )

The denominator for basic and diluted net loss per share is the weighted average number of unrestricted common shares outstanding for the periods presented. In periods of net income, the denominator for diluted net income per share also includes potentially dilutive shares, which consist of shares issuable upon the exercise of dilutive stock options and contingently issuable shares. These shares are excluded from the computations of diluted net loss per share for the three months ended June 24, 2011 and June 25, 2010 as they are anti-dilutive and would therefore reduce the loss per share. The total amount of such anti-dilutive shares was 132,000 and 331,000 for the three months ended June 24, 2011 and June 25, 2010, respectively.

At June 24, 2011, there are 770,000 shares of common stock issuable upon conversion of the 3¾% convertible senior notes and 753,000 shares of common stock issuable upon conversion of the 7¼% redeemable convertible subordinated debentures. For all periods presented, these shares and the related effect of the accrued interest are excluded from the calculation of diluted net loss per share, as their inclusion would be anti-dilutive.

Note 5.  Restructure and Other Costs

There were no charges for restructuring costs in the three months ended June 24, 2011 and June 25, 2010.

The liability for restructuring was $595,000 at June 24, 2011 and consisted solely of accrued costs to exit the Company’s former manufacturing facility. Changes in accrued amounts related to restructuring during fiscal 2012 were as follows:

(in thousands)
  
Restructure
Accrual
  
Balance at March 25, 2011
   $ 915  
Provision
     —  
Payments
     (335 )
Other (1)
     15  
Balance at June 24, 2011
   $ 595  

 
(1)
Consists primarily of accretion of implied interest on the remaining liability for lease and other exit costs associated with the Company’s former manufacturing facility which is reflected in general and administrative expense in the condensed consolidated statement of operations and comprehensive loss.

Note 6.  Income Taxes

The Company recorded tax provisions of $72,000 and $51,000 respectively, for the three months ended June 24, 2011 and June 25, 2010. Provisions for income tax are primarily related to the Company’s international operations.

Note 7.  Contractual Obligations and Commercial Contingencies

3¾% Convertible Senior Notes:  In December 2007, the Company issued $85.0 million of 3¾% convertible senior notes due December 15, 2014, in a private placement, of which $10.5 million remained outstanding at June 24, 2011. A note may be converted by a holder, at its option, into shares of the Company’s common stock initially at a conversion rate of 73.3689 shares of common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $13.63 per share of common stock (subject to adjustment in certain events), at any time on or prior to December 15, 2014, unless the notes were previously repurchased. If a holder elects to convert its notes in connection with certain fundamental changes, in certain circumstances the conversion rate will increase by a number of additional shares of common stock upon conversion. Upon conversion, a holder generally will not receive any cash payment representing accrued and unpaid interest, if any. The notes are not redeemable by the Company prior to the stated maturity.

 
10

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(continued)
 
Upon the occurrence of certain fundamental changes including, without limitation, an acquisition of voting control of the Company, the liquidation or dissolution of the Company, or the Company’s common stock ceasing to be traded on a U.S. national securities exchange, a holder may require the Company to purchase for cash all or any part of its notes at a purchase price equal to 100% of the principal amount plus any accrued and unpaid interest (including additional interest, if any) up until, but not including, the fundamental change purchase date.

The notes are unsecured senior obligations, ranking equal in right of payment to all existing and future senior indebtedness, and senior in right of payment to any existing and future subordinated indebtedness. The notes are effectively subordinated to existing and future secured indebtedness to the extent of the assets securing such indebtedness and structurally subordinated to the claims of all existing and future indebtedness and other liabilities of the Company’s subsidiaries.

7¼% Redeemable Convertible Subordinated Debentures:  In May 1989, the Company issued $75.0 million of 7¼% redeemable convertible subordinated debentures due May 15, 2014, of which $23.7 million remained outstanding at June 24, 2011. Each debenture is convertible at the option of the holder into common stock at $31.50 per share and is redeemable at the option of the Company. The debenture holders are entitled to a sinking fund which began May 15, 2000, of 14 annual payments of 5% of the aggregate principal amount of debentures issued ($3.8 million annually), reduced by any redemption or conversion of the debentures. As a result of previous redemptions, the total remaining sinking fund requirement is $1.2 million, which, assuming no further redemptions, will be due as a final sinking fund payment on May 15, 2013.

License and Development Agreement: The Company is a party to a license and development agreement with a third-party technology supplier, under which the Company acquired a license to manufacture and distribute the supplier’s high-speed networking platform. The Company agreed to pay an additional $5.0 million in four equal installments to the supplier for the advanced platform and an extended exclusive right to market. The first two installments were paid in fiscal 2008 and the remaining two will be due at separate future dates dependent upon the supplier’s delivery of future enhancements of the advanced platform. The Company believes it is unlikely the remaining two installments will become due or be paid.

Contingencies:  In the normal course of business, the Company enters into contractual commitments to purchase services, materials, components, and finished goods from suppliers, mainly its primary contract manufacturer, Plexus. Under the agreement with Plexus, the Company may incur certain liabilities, as described in Note 3.

Contractual obligations and contingencies decreased from $52.5 million at March 25, 2011 to $50.4 million at June 24, 2011. This decrease resulted principally as a result of ongoing interest and operating lease payments.

The Company has learned that some of its products may have been exported or re-exported in violation of U.S. export laws. Consequently, the Company has launched an internal investigation of its export-related activities, which is being performed by outside counsel. The Company has provided preliminary disclosures regarding these transactions to the U.S. Department of Commerce and the U.S. Department of Treasury, is cooperating fully with requests from these entities, and will provide a full report to these entities at the conclusion of the internal investigation. If the U.S. government finds that the Company has violated U.S. export laws, the Company could be subject to various penalties. By statute, these penalties can include but are not limited to fines of up to $250,000 for each violation, debarment from government business, or loss of export privileges. The Company believes, however, that its cooperation with the U.S. government, its immediate attention to rectifying the issues, and other factors provide a basis for mitigating any penalty that might be imposed. As a result of the discovery of these events, the Company has implemented more stringent export control procedures. At this time, the Company cannot determine an estimated cost, or range of costs, such as for penalties or fines, that may be incurred upon resolution of this matter. Accordingly, no provision has been provided for this matter.
 
Litigation:
See Note 10.
 
Note 8.  Stock-based Compensation

Stock Option and Award Plans:  The Company grants options to purchase shares of its common stock and is authorized to award restricted shares of common stock pursuant to the terms of its 2008 Equity Incentive Plan, its 1993 Stock Option Plan and its 1997 Stock Option Program. Upon stockholder approval of the 2008 Equity Incentive Plan in August 2008, the 1993 Stock Option Plan and the 1997 Stock Option Program were terminated, and all shares available for future grants of awards under the 1993 Stock Option Plan and the 1997 Stock Option Program were terminated.

 
11

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(continued)
 
Stock options generally become exercisable ratably over a four-year period and expire after seven to ten years. Options may be granted to officers, employees, directors and independent contractors to purchase common stock at a price not less than 100% of the fair market value at the date of grant. Stock option exercises were none and 10,041 shares in the three months ended June 24, 2011 and June 25, 2010, respectively.

Restricted stock awards (“RSAs”) granted under the equity plans are independent of option grants and are subject to restrictions. RSAs, which have been issued since fiscal 2007, are subject to forfeiture if employment or services are terminated prior to the release of restrictions, which generally occurs on a ratable basis over one to two years from the date of grant. Until the restriction is released, the shares cannot be transferred. These shares have the same cash dividend and voting rights as other common stock and are considered as issued and outstanding. The cost of the awards, determined to be the fair market value of the shares at the date of grant, is expensed ratably over the period the restrictions lapse.

Restricted stock unit awards (“RSUs”) granted under the 2008 Equity Incentive Plan are also independent of option grants and are subject to restrictions. RSUs are subject to forfeiture if employment or services are terminated prior to the release of restrictions, which generally occurs on a ratable basis over periods ranging from one day to two years from the date of grant. Until the restriction is released, the shares cannot be transferred. These shares are not considered as issued and outstanding until the release of restrictions. The cost of the awards, determined to be the fair market value of the shares at the date of grant, is expensed ratably over the period the restrictions lapse.

Upon the release of restriction, a portion of the released shares are repurchased from employees by the Company to satisfy withholding-tax obligations arising from the vesting of restricted stock awards. The Company repurchased 37,457 shares from employees in the three months ended June 24, 2011 for a total price of $113,000.

Stock Compensation Expense: Stock-based compensation expense for the three months ended June 24, 2011 and June 25, 2010, was as follows:

(in thousands)
  
Three Months Ended
  
   
June
24, 2011
    
June
25, 2010
  
Cost of revenue
   $ 125     $ 199  
Sales and marketing
     227       390  
Research and development
     317       508  
General and administrative
     214       349  
    $ 883     $ 1,446  

The fair value of the Company’s stock option awards granted to employees was estimated using the following weighted-average assumptions:

   
Three Months Ended
  
   
June
 24, 2011
    
June
 25, 2010
  
Expected term, in years
     4.97       4.94  
Expected volatility
     76.14 %     72.81 %
Risk-free interest rate
     1.53 %     1.90 %
Expected dividends
     —       —  
Weighted-average fair value
   $ 1.88     $ 2.94  


 
12

NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(continued)
 
Note 9.  Financial Instruments Fair Value Disclosure

The estimated fair values of the Company’s financial instruments at June 24, 2011 and March 25, 2011 were as follows:

(in thousands)
  
June
24, 2011
    
March
25, 2011
  
   
Carrying
Amount
    
Estimated
Fair Value
    
Carrying
Amount
    
Estimated
Fair Value
  
Assets:
                        
Short-term investments
   $ 46,790     $ 46,790     $ 56,860     $ 56,860  
Liabilities:
                                
3¾% Convertible senior notes
   $ 10,500     $ 8,709     $ 10,500     $ 8,709  
7¼% Redeemable convertible subordinated debentures
   $ 23,704     $ 20,179     $ 23,704     $ 21,334  

The gross unrealized holding gains (losses) on available-for-sale securities for short term investments recorded in accumulated other comprehensive loss were not material as of June 24, 2011 and March 25, 2011 respectively.

The following methods and assumptions were used in estimating the fair values of financial instruments:

Cash and cash equivalents:  The carrying amounts reported in the balance sheets for cash and cash equivalents approximate their estimated fair values due to their short maturities.

Short-term investments:   Fair values are based on quoted market prices and observable prices that are based on inputs not quoted on active markets, but corroborated by market data. See Note 2.

Restricted cash:  The carrying value approximates fair value.

Accrued liabilities:  The carrying value approximates fair value.

Convertible debt: The Company has estimated the approximate fair value of these securities using the quoted market price or trade closest to June 24, 2011. The Company has determined that its convertible debt should be classified as Level 2 within the fair value hierarchy. See Note 2.

Foreign exchange contracts:  The Company does not use derivative financial instruments for speculative or trading purposes. Where available, the Company enters into foreign exchange forward contracts to hedge certain balance sheet exposures and intercompany balances against future movement in foreign exchange rates. Gains and losses on the foreign exchange contracts are included in other income and expense, net, which offset foreign exchange gains or losses from revaluation of foreign currency-denominated balance sheet items and intercompany balances.

The foreign exchange forward contracts require the Company to exchange foreign currencies to U.S. dollars or vice versa, and generally mature in one month or less. As of June 24, 2011 and March 25, 2011, the Company had outstanding foreign exchange forward contracts with aggregate notional amounts of $5.8 million and $5.9 million, respectively, which had remaining maturities of one month or less. As of June 24, 2011, the carrying amount, which was also the estimated fair value of the foreign exchange forward contracts, was based on prevailing financial market information. The amounts recorded on the condensed consolidated balance sheets and statements of operations for foreign exchange contracts are not material.

Note 10.  Litigation
 
A subsidiary of the Company, Quintum Technologies, LLC (Quintum), is party, by interpleader, to three related lawsuits in Greece filed by Lexis SA, a former distributor of Quintum products in Greece. The initial interpleader lawsuit was filed October 26, 2006, at the Multimember First Instance Court of Athens. The first two of these lawsuits were initially filed against Lexis by one of its customers, Advanced Telecom Systems (“ATS”), alleging that a set of hardware and software products acquired for ATS by Lexis failed to perform as a system. The products include Quintum’s hardware product and a software product by another vendor, Ipercom. In these first two lawsuits, the customer (ATS) seeks damages from the distributor (Lexis), and the distributor has interpleaded the product vendors, Quintum and Ipercom, asking them to pay any amounts that Lexis may be ordered to pay to ATS, who seeks a refund of amounts paid for the purchase of the hardware and software, totaling €78,215, and compensation for real and moral damages, totaling €4,054,893. The third lawsuit was initiated by one of ATS’ customers for non delivery of services, which were to be delivered through the system ATS purchased from Lexis. In this lawsuit, the ATS customer seeks various monetary damages totaling €2,859,847. ATS filed an interpleader lawsuit against Lexis and Lexis has filed the same against Quintum and Ipercom. Hearings on all the lawsuits and interpleader lawsuits are currently scheduled for February 2012. The Company has not accrued any amounts related to the claim, as it believes that a negative outcome is not probable.
 
The Company is currently a party to various legal proceedings. Management presently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not materially harm the Company’s financial position, cash flows, or results of operations. However, legal proceedings are subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling could include money damages or, in matters for which injunctive relief or other conduct remedies are sought, an injunction prohibiting the Company from selling one or more products at all or in particular ways. Were unfavorable final outcomes to occur, there could be a material adverse impact on the Company’s business, results of operations and financial position.

 
13


This discussion and analysis should be read in conjunction with the condensed consolidated financial statements included in this Form 10-Q and Part II of our Form 10-K for the fiscal year ended March 25, 2011. Statements contained in this Form 10-Q 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,” “expect to,” “anticipate that,” “to be,” or “can affect.” Forward-looking statements are based upon management expectations, forecasts and assumptions that involve risks and uncertainties that may cause actual results to differ materially from those expressed or implied 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-Q and our most recently filed Form 10-K. The Company expressly disclaims any obligation or undertaking to revise or publicly release any updates or revisions to any forward-looking statement contained in this Form 10-Q except as required by law. Investors should carefully review any risk factors described in this Form 10-Q and our most recently filed Form 10-K, along with other documents the Company files from time to time with the Securities and Exchange Commission.

References to “fiscal 2012” or “fiscal 2011” generally refer to the specific periods presented in this discussion.

Our Business

Network Equipment Technologies, Inc. (“NET”), founded in 1983, develops and sells high performance networking equipment optimized for real-time communications. For more than a quarter of a century, NET has delivered solutions for multi-service networks requiring high degrees of versatility, security and performance. Today, the company is focused on providing secure real-time communications for unified communications (“UC”), session-initiation protocol (“SIP”) trunking, enterprise mobility, and IP-based multi-service networking. In 2007, in order to enhance our lineup of voice over IP (“VoIP”) offerings, we acquired Quintum Technologies and its Tenor product line.

Our enterprise customer base includes large enterprises adopting UC and small- to mid-sized businesses (“SMBs”) implementing real-time communications. Our government customers include a variety of federal and international agencies and organizations, including civilian and defense agencies and resellers to such entities. In addition to our direct sales capabilities, we have developed relationships with integrators, resellers, and vendors of related technologies in order to help drive our enterprise business. Our global support and service organization, along with third-party service organizations, provides installation and other professional services, a variety of maintenance programs, technical assistance, and customer training.

Today, our solutions are focused on enabling our enterprise and government customers to cost-effectively migrate to next-generation IP networks utilizing real-time communications, including unified communications platforms, cloud-based voice, secure voice applications, and high-speed multiservice wide area networking (“WAN”) transport networks. Our newest product offering, the UX Series, was purpose-built for the unified communications and enterprise “session border controller”  markets to enable adoption of new communication technologies and services. Our voice solutions include the VX Series and the Tenor lines of switching media gateways. Our legacy multi-service solutions include the Promina platform and the NX Series high speed multi-service network exchange platform.

The UX Series is an enhanced gateway with an embedded server that acts a survivable branch appliance, which is a key component for remote-site survivability. The UX Series interoperates with our VX Series and Tenor products and was specifically designed to support upstream deployments with advanced features that give customers high levels of flexibility, scalability, quality of experience, and investment protection through interoperability. The VX Series and Tenor product lines provide enterprise customers with voice interoperability solutions that enable existing private branch exchange (PBX) and IP-PBX systems to work together with new UC platforms and IP-based service provider networks offering SIP trunking services. The VX Series also provides IP-based solutions to government agencies requiring high bandwidth efficiency and call performance for secure voice communications. The Tenor product line also provides traditional VoIP switching gateway solutions for SMBs and smaller branch offices within large enterprises.

Our legacy multi-service solutions include the Promina, NX1000 and NX5010 platforms. The Promina product line has been serving government agencies and large enterprises for many years, providing industry-leading network reliability and security. The NX Series products are high-performance networking platforms that provide high-grade data transfer and enable secure grid computing. Our NX1000 platform provides an extensive, compact, WAN switching solution that enables applications to integrate and aggregate into IP-based networks. The NX5010 platform enables high-speed, secure interconnection and extension of geographically distributed grid computing clusters and storage area networks.

 
14

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Such estimates and assumptions, which we evaluate on an on-going basis, include, but are not limited to: assumptions related to contracts that have multiple elements, the allowances for sales returns and potentially uncollectible accounts receivable, the valuation of inventory, warranty costs, the valuation allowance on deferred tax assets, certain reserves and accruals, estimated lives of depreciable assets, and assumptions related to stock-based compensation. We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances. Actual results could differ from those estimates.

There have been no significant changes to our policies and estimates, as discussed in our Annual Report on Form 10-K for the fiscal year ended March 25, 2011.

Recent Accounting Pronouncements

See Note 1 of our Notes to Condensed Consolidated Financial Statements for recent accounting pronouncements, including the expected dates of adoption and estimated effects on our consolidated financial statements.

Results of Operations

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

   
Three Months Ended
  
   
June
24, 2011
    
June
25, 2010
  
Percent of revenue
            
Product
     68.1 %     74.1 %
Service and other
     31.9       25.9  
Total revenue
     100.0       100.0  
                 
Product gross margin
     30.5       43.7  
Service and other gross margin
     41.6       11.0  
Total gross margin
     34.0       35.2  
                 
Sales and marketing
     39.5       35.1  
Research and development
     42.6       37.4  
General and administrative
     22.0       20.2  
Total operating expenses
     104.1       92.7  
Loss from operations
     (70.1 )     (57.5 )
                 
Interest expense, net
     (4.0 )     (2.4 )
Other income (expense), net
     0.3       (0.6 )
Loss before taxes
     (73.8 )     (60.5 )
Income tax provision
     0.6       0.4  
Net loss
     (74.4 )%     (60.9 )%

Overview and Highlights

 
·
Total revenue decreased in the first quarter of fiscal 2012 due mostly to lower sales to government customers. Sales to the government sector can fluctuate significantly from quarter to quarter, but have declined substantially in recent quarters. The decline is primarily attributable to program delays and spending gridlock by the U.S. government. Our legacy products have seen sales declines and our newer products are targeted for different solutions and will require marketing towards these new solutions in order to achieve broader adoption in the government sector.

 
·
We are transitioning our product line to address unified communications and other new telecommunications opportunities. Sales of our UX Series product, which was introduced in the third quarter of fiscal 2011, are increasing, but we have not yet released a full product family on that platform. Meanwhile, sales have declined for our Promina and other multi-service products, as well as for our VoIP-based VX Series product.

 
15

 
·
Our sector mix and our mix of product sales fluctuate quarter to quarter. We expect our customers to move to IP-based communications, at varying speeds. Also, spending by government customers fluctuates based on budget allocations, the timely passage of the annual federal budget, and the timing of specific programs and purchasing for those programs. The following table shows elements of our sector mix and our mix of product sales:

(in thousands, except percentages)
  
Three Months Ended
   
June
24, 2011
  
June
25, 2010
Sector mix:
                
Revenue from government customers
  
$
5,965
    
$
9,741
  
% of total revenue
    
52.7
%
    
72.3
%
Mix of product sales:
                
Promina product revenue
  
$
1,936
    
$
3,303
  
% of product revenue
    
25.1
%
    
33.1
%
VoIP-based product revenue
  
$
4,825
    
$
5,748
  
% of product revenue
    
62.7
%
    
57.6
%
Other product revenue
  
$
863
    
$
809
  
% of product revenue
    
11.2
%
    
8.1
%

 
·
Product margin was down as a result of reduced sales and a changing mix of products. With reduced sales, we are unable to take advantage of economies of scale, and have also had to take reserves for excess or obsolete inventory. In addition, we had achieved a higher gross margin on our legacy products, which make up a declining portion of our revenue mix, compared to the gross margin for our more recently introduced products, which also have not yet benefitted from on-going cost reduction efforts or volume purchasing.

 
·
Service margin was up in the first quarter of fiscal 2012 compared to the first quarter of the prior year. Our arrangement with CACI International Inc. (“CACI”) for the sharing of maintenance and other services expired December 1, 2010. We now perform these services ourselves, with a relatively small increase in cost, and no longer have the cost of remitting to CACI any payment based on the revenue associated with these services.

 
·
Expense levels were generally consistent with prior periods. We continue to manage expenses and cash closely. Operating expense in the first quarter of fiscal 2012 decreased 5.7% from the prior year, due largely to reduced charges for our headquarters facility lease.

Revenue
   
Three Months Ended
        
(in thousands, except percentages)
  
June
24, 2011
    
June
25, 2010
    
Change
  
Product
   $ 7,699     $ 9,987       (22.9 )%
Service and other
     3,614       3,494       3.4  
Total revenue
   $ 11,313     $ 13,481       (16.1 )%

Total revenue decreased in fiscal 2012, due to a decline in product revenue.

On a sector basis, product revenue from government customers declined $3.8 million, offset in part by a $1.5 million increase in sales to commercial customers. On a product-line basis, the decrease in product revenue was mostly due to reduced sales of our Promina and VX Series products, although international sales of VX Series products were up slightly. Basic VoIP application product sales have remained essentially flat as we shift our focus to more-advanced unified communications, SIP trunking, and other applications supported by our VX Series product and now by our UX Series product.

 
16

We expect our mix of product sales and our sector mix to fluctuate quarter to quarter, with commercial sales expected to outpace government sales in fiscal year 2012. Sales to our government customers can fluctuate based upon passage of the annual budget and the timing of specific government programs.

Service and other revenue increased slightly in fiscal 2012. Significant fluctuations in our service and other revenue can occur as a result of factors affecting the timing of the recognition of revenue, including customer deployment schedules, contractual acceptance provisions and renewal of annual support agreements.

Gross Margin

   
Three Months Ended
  
   
June
24, 2011
    
June
25, 2010
  
Product gross margin
     30.5 %     43.7 %
Service and other gross margin
     41.6       11.0  
Total gross margin
     34.0 %     35.2 %

Total gross margin decreased in fiscal 2012 as lower product margin outweighed improvements in service and other margin.

Product margin was down primarily due to a lower amount of product revenues available to absorb manufacturing overhead. In addition, lower sales of Promina products contributed to lower product margin, as Promina products have higher gross margin than our more recently introduced products, which also have not yet benefitted from on-going cost reduction efforts or volume purchasing. Product margin can also be affected by inventory reserve charges. As part of our arrangement with our principal contract manufacturer, the manufacturer holds significant amounts of raw materials, components and product inventory on our behalf. Under certain circumstances, we may be required to make deposits on the inventory, and if the inventory continues to remain on hand, to purchase the inventory underlying the deposit. We may subsequently need to write down or write off the inventory. Inventory reserve charges for the first quarters of fiscal 2012 and fiscal 2011 were $247,000 and $291,000, respectively.

Service and other gross margin improved due largely to the termination of the revenue sharing arrangement with our former service partner, CACI, in December 2010. We now perform these services ourselves, with a relatively small increase in cost, and no longer have the cost of remitting to CACI any payment based on the revenue associated with these services. This cost reduction was partially offset by relatively small increases in costs relating to an expansion of our support staff, through increased headcount and by re-assigning some existing personnel from our sales organization.

Operating Expenses

(in thousands, except percentages)  
Three Months Ended
        
 
  
June
24, 2011
    
June
25, 2010
    
Change
  
Sales and marketing
   $ 4,464     $ 4,733       (5.7 )%
Research and development
     4,821       5,039       (4.3 )
General and administrative
     2,498       2,726       (8.4 )
Total operating expenses
   $ 11,783     $ 12,498       (5.7 )%

Operating expense in fiscal 2012 decreased due principally to lower facilities costs and slightly lower salary cost. Facilities costs were lower due principally to reduced charges for our headquarters facility lease. Overall salary cost was lower due to reduced headcount and to the re-assignment of some technical sales support personnel to our service organization.

Sales and marketing expense:

Sales and marketing expense was lower in fiscal 2012 by $270,000. Payroll-related costs were $307,000 lower, due principally to the effect of the re-assignment of some technical sales support staff to our service organization following termination of the CACI arrangement in December, 2010. Allocated facilities costs were $106,000 lower. These cost decreases were partially offset by higher sales commissions, which were higher by $76,000 and miscellaneous other costs, which in the aggregate were $68,000 higher.

Research and development expense:

Research and development expense was $218,000 lower in fiscal 2012. Allocated facilities costs were $237,000 lower, payroll-related costs were $291,000 lower, and miscellaneous other costs, in the aggregate, were $17,000 lower. These cost decreases were partially offset by higher consulting costs, which increased by $327,000 due to UX1000 product development efforts.

 
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General and administrative expense:

General and administrative expense was lower in fiscal 2012 by $228,000. Legal costs were lower by $198,000 due to reduced patent lawsuit defense costs, allocated facilities costs were lower by $92,000, and miscellaneous other costs, in the aggregate, were lower by $28,000. These cost decreases were partially offset by a $149,000 increase in outside services fees, principally for audit and tax services.

Non-Operating Items

(in thousands, except percentages)
  
Three Months Ended
        
   
June
 24, 2011
    
June
 25, 2010
    
Change
  
Interest income
   $ 106     $ 224       (52.7 )%
Interest expense
   $ (553 )   $ (552 )     0.2  
Other income (expense), net
   $ 34     $ (81 )     (142.0 )

Interest income was lower in fiscal 2012 due to lower average interest earned on investments, and to lower average cash and investment balances. Average cash and investment balances were lower primarily due to the effect of operating losses in the full fiscal year 2011 and in the first three months of fiscal 2012.

Interest expense in the first quarter of fiscal 2012 and 2011 was virtually equivalent, as the balance of long-term debt was identical throughout each of the two periods.

Other income (expense), net, consisted of:

(in thousands)
  
Three Months Ended
  
   
June
 24, 2011
    
June
25, 2010
  
Gain (loss) on foreign exchange
   $ 2     $ (147 )
Realized gain on investments
     36       70  
Other
     (4 )     (4 )
    $ 34     $ (81 )

Income Tax Provision

Income tax provisions were $72,000 and $51,000, respectively, in the first quarter of fiscal 2012 and 2011. Provisions for income tax are primarily related to our international operations.

Liquidity and Capital Resources

Historically, our primary sources of liquidity and capital resources have been our cash and investment balances, cash provided by operating activities and debt financing activities.

Cash balances:  As of June 24, 2011, cash and cash equivalents, short-term investments and restricted cash were $54.1 million, as compared to $61.4 million as of March 25, 2011. At June 24, 2011, these amounts were invested 47% in U.S. Treasury notes and government agency investments and cash equivalents.

Cash flow from operating activities:

Net cash used by operating activities was $7.1 million in fiscal 2012 compared to $4.5 million in fiscal 2011.

The increase in net cash used in operating activities in fiscal 2012 resulted principally from changes in asset and liability balances and, to a lesser extent, by changes in non-cash activities and net losses.

Changes in accounts receivable balances were responsible for a $2.3 million increase in net cash used in operating activities. Collections on accounts receivable were lower in fiscal 2012 due to lower revenues in the fourth quarter of fiscal 2011 and the first quarter of fiscal 2012 compared to the same periods a year ago. Changes in balances of prepaid accounts were responsible for an increase of $920,000 in net cash used in operating activities. While prepaid accounts decreased in both fiscal 2012 and 2011, the difference was greater in fiscal 2011 due principally to reductions in inventory deposits and receipt of escrowed amounts relating to the Quintum acquisition. Changes in inventory balances were responsible for an increase of $439,000 in net cash used in operating activities. Changes in accounts payable and accrued liability balances were responsible for a $1.8 million decrease in net cash used in operating activities. While accounts payable and accrued liabilities balances decreased in both fiscal 2012 and fiscal 2011 the change was greater in fiscal 2011. Higher revenues in the fourth quarter of fiscal 2010, resulted in greater payments in the first quarter of fiscal 2011, for inventory and sales commissions.

 
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Stock-based compensation expense was lower in fiscal 2012, primarily because the Company ended its program of granting restricted stock to offset salary reductions. Depreciation, amortization and accretion charges were lower in fiscal 2012 as equipment reaching the end of depreciation periods exceeded acquisitions of new equipment. Net losses were slightly greater in fiscal 2012 than in fiscal 2011.

Cash flow from investing activities:

Net cash provided by investing activities was $9.9 million in fiscal 2012 compared to $3.2 million in fiscal 2011. The principal reason for this change was the net effect upon cash of purchases, sales and maturities of short-term investments. These activities provided net cash of $10.1 million and $3.6 million in fiscal 2012 and 2011, respectively.

We used the cash provided by investing activities in fiscal 2012 principally to fund operating activities.

Cash flow from financing activities:

Net cash used in financing activities was $145,000 in fiscal 2012 compared to $300,000 in fiscal 2011.

The principal financing activity in both fiscal 2012 and fiscal 2011 was repurchases of common stock from employees to satisfy withholding-tax.

Our contractual obligations and contingencies decreased by $2.1 million from March 25, 2011. This decrease was principally due to ongoing interest and operating lease payments. The following table provides a summary of our contractual obligations and other commercial commitments as of June 24, 2011:

Contractual obligations
(in thousands)
 
  
Total
    
2012
    
2013
to
2014
    
2015
to
2016
    
After
2016
  
Long-term debt
   $ 34,204     $ —     $ 1,204     $ 33,000     $ —  
Interest on long-term debt
     6,534       1,056       4,225       1,253       —  
Operating leases
     9,460       2,542       3,391       2,551       976  
Capital leases
     217       72       99       46       —  
Total contractual obligations
   $ 50,415     $ 3,670     $ 8,919     $ 36,850     $ 976  

Included in the operating lease amounts are payments on our former manufacturing facility. Of those payments, $158,000, representing the discounted value of the lease payments net of sublease income, is accrued in our restructure liability at June 24, 2011.

We have a contract with a third-party technology supplier that calls for payment by us of $2.5 million upon receipt of deliverables meeting certain conditions.

We have a long-term income tax liability for uncertain tax positions amounting to $607,000 at June 24, 2011. We cannot currently predict the date of settlement or payment, as the timing of resolution of our liability is highly uncertain.

In the normal course of business, we enter into contractual commitments to purchase services, materials, components, and finished goods from suppliers, mainly our primary contract manufacturer, Plexus. Under our agreement with Plexus, which runs through December 31, 2011, we maintain a level of control over parts procurement, design, documentation, and selection of approved suppliers. We are generally liable for any termination or cancellation of product orders, as well as excess and obsolete material, which can result, for example, from an engineering change, product obsolescence, or inaccurate component forecasting. Under the agreement, Plexus is to procure raw materials and begin manufacturing of products in accordance with our forecasts. If certain purchased raw materials or certain work-in-process items are held for greater than 90 days, we must make deposits on the aging inventory, although Plexus must make efforts to minimize our liability for the aging inventory, including returning materials to suppliers, canceling orders with suppliers, or using materials to manufacture product for its other customers. If raw material or in-process inventories are still unused and have been held for more than nine months, we must take ownership and pay for the aged inventory. Alternatively, if there is forecasted demand for such inventory, we must pay a management fee for Plexus to retain such inventory. If the forecasted demand does not materialize we must take ownership and pay for such inventory. This activity may increase our owned inventories.

 
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At June 24, 2011, Plexus held inventory related to our products. Our deposit relating to this inventory was $3.8 million at June 24, 2011 and reserves relating to this deposit were $1.2 million at June 24, 2011. Both the deposit and the related reserves are included in prepaid expenses and other assets on the condensed consolidated balance sheets. Additional deposits may be required under the terms of the agreement.

Other contingencies:  We have learned that some of our products may have been exported or re-exported in violation of U.S. export laws. Consequently, we have launched an internal investigation of our export-related activities, which is being performed by outside counsel. We will report the results of the investigation to the U.S. government. Certain issues subject to the investigation have already been reported to the U.S. government, and the U.S. government has closed a limited portion of the matter with the issuance of a warning letter. The results of the rest of the internal investigation will be reported to the U.S. government in due course. If the U.S. government finds that we have violated one or more export control laws or trade sanctions, we could be subject to various penalties. By statute, these penalties can include but are not limited to fines of up to $250,000 for each violation, denial of export privileges, and debarment from participation in U.S. government contracts. We believe, however, that our cooperation with the U.S. government, our immediate attention to rectifying the issues, and other factors provide a basis for mitigating any penalty that might be imposed. As a result of the discovery of these events, we have implemented more stringent export control procedures. We believe it is reasonably possible that we could incur a loss as a result of penalties relating to these events. However, at this time, we cannot determine an estimated cost, if any, or range of costs, for any such penalties or fines that may be incurred upon resolution of this matter. Accordingly, we have not made a provision for this matter.

We believe that our existing cash, cash equivalents and short-term investments will be sufficient to fund operations for at least the next twelve months. We believe the most strategic uses of our cash resources in the near term will include investments in new technologies, expansion of our sales capabilities, and working capital.

Off-balance sheet arrangements: Other than the commitments described above, there are no other off-balance sheet arrangements that are reasonably likely to materially affect our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.


The following are the material changes for the three months ended June 24, 2011 from the information reported under Part II, Item 7A of our Form 10-K for the fiscal year ended March 25, 2011:

A 10% change in market interest rates would change the fair value of our investment portfolio by $22,000, as compared to a change of $44,000 as of March 25, 2011.

A 10% change in the foreign currency rates affecting our foreign exchange contracts as of their June 24, 2011 levels would change the fair value of the contracts by $580,000, as compared to a change of $590,000 for the contracts as of March 25, 2011.

The fair market values of our 3¾% convertible senior notes and our 7¼% redeemable convertible subordinated debentures are sensitive to changes in interest rates and to the price of our common stock into which they can be converted, as well as our financial stability. The yield to maturity on the notes and the debentures is fixed, therefore the interest expense on our debt does not fluctuate with interest rates.

The fair value of the 3¾% convertible senior notes was $8.7 million as of both June 24, 2011 and March 25, 2011. The fair value of the 7¼% redeemable convertible subordinated debentures was $20.2 million at June 24, 2011 and $21.3 million at March 25, 2011.


In accordance with Section 302 of the Sarbanes-Oxley Act of 2002 and Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, management, under the supervision and with the participation of the chief executive officer (“CEO”) and chief financial officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) at the end of the period covered by this report as well as any changes in disclosure controls and procedures that occurred during the period covered by this report. Our management, including our CEO and CFO, has concluded that our disclosure controls and procedures are effective as of June 24, 2011.

No changes in our internal control over financial reporting occurred during the quarter ended June 24, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 
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There have been no material changes in disclosure controls and procedures since the filing of the Company’s annual report on Form 10-K for the fiscal year ended March 25, 2011. We intend to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and 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 significantly modify our disclosure controls and procedures.

PART II - OTHER INFORMATION


No changes.


Our business is subject to the risks and uncertainties described in our most recent annual report on Form 10-K. There may be additional risks that have not yet been identified and risks that are not material now but could become material. Any one of these risks could hurt our business, results of operations or financial condition. Investors should carefully review the risk factors described in our most recent Annual Report on Form 10-K.
 

(c) Issuer Purchases of Equity Securities

Common Stock

The following table reflects purchases made by the Company of its common stock during the quarter ended June 24, 2011:

Fiscal Period
  
Total Number of Shares Purchased (1)
    
Average Price Paid Per Share
    
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
    
Approximate Dollar Value of Shares That May Yet Be Purchased Under the Publicly Announced Plans or Programs
  
March 26 – April 22, 2011
     —       —       —     $ —  
April 23 – May 20, 2011
     37,457     $  3.02     $ —     $ —  
May 21 – June 24, 2011
     —       —       —     $ —  
       37,457     $   3.02     $ —     $ —  

 
(1)
During the quarter ended June 24, 2011, 37,457 shares were acquired directly from employees as payment of tax withholding obligations upon vesting of restricted stock awards.


Not applicable.


Not applicable.


 
(a)
Exhibits
 
Rule 13a-14(a) Certification (CEO).
   
Rule 13a-14(a) Certification (CFO).
   
Section 1350 Certification (CEO).
   
Section 1350 Certification (CFO).
   
101.INS
XBRL Instance Document
   
101.SCH
XBRL Schema Document
   
101.CAL
XBRL Calculation Linkbase Document
   
101.LAB
XBRL Label Linkbase Document
   
101.PRE
XBRL Presentation Linkbase Document
   
101.DEF
XBRL Definition Linkbase Document
 
 
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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.

Dated:  August 2, 2011
NETWORK EQUIPMENT TECHNOLOGIES, INC.
  
     
 
By:    /s/ C. NICHOLAS KEATING, JR.
  
 
President and Chief Executive Officer
  
     
     
 
By:    /s/ DAVID WAGENSELLER
  
 
Vice President and Chief Financial Officer
(Principal Financial Officer)
  
     
     
 
By:    /s/ KAREN CARTE
  
 
Vice President and Chief Accounting Officer
(Principal Accounting Officer)
  


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