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 September 24, 2010. 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 October 22, 2010 was 30,057,000.  NETWORK EQUIPMENT TECHNOLOGIES, INC. INDEX PART I.  FINANCIAL INFORMATIONItem 1.  Financial StatementsCondensed Consolidated Balance Sheets at September 24, 2010 and March 26, 2010Condensed Consolidated Statements of Operations and Comprehensive Loss  Three and Six Months Ended September 24, 2010 and September 25, 2009Condensed Consolidated Statements of Cash Flows  Six Months Ended September 24, 2010 and September 25, 2009Notes to Condensed Consolidated Financial StatementsItem 2.  Management's Discussion and Analysis of Financial Condition and Results of OperationsItem 3.  Quantitative and Qualitative Disclosures about Market RiskItem 4.  Controls and ProceduresPART II.  OTHER INFORMATIONItem 1.  Legal ProceedingsItem 1A.  Risk FactorsItem 2.  Unregistered Sales of Equity Securities and Use of ProceedsItem 3.  Defaults Upon Senior SecuritiesItem 5.  Other InformationItem 6.  ExhibitsSIGNATURES   PART I - FINANCIAL INFORMATION ITEM 1.  FINANCIAL STATEMENTS NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Balance Sheets(Unaudited  in thousands, except par value)  September
24, 2010March
26, 2010Current assets:Cash and cash equivalents$3,960$4,953Short-term investments66,02275,508Restricted cash2,192554Accounts receivable, net of allowances of $263 at September 24, 2010 and $265 at March 26, 201013,56713,468Inventories3,9174,377Prepaid expenses and other assets5,7097,961Total current assets95,367106,821Property and equipment, net4,6985,155Other assets5,2765,710Total assets$105,341$117,686Current liabilities:Accounts payable$7,915$7,987Accrued liabilities11,44813,230Total current liabilities19,36321,217Long-term liabilities:33⁄4% convertible senior notes10,50010,50071⁄4% redeemable convertible subordinated debentures23,70423,704Capital lease obligation, less current portion7969Other long-term liabilities1,4662,092Total long-term liabilities35,74936,365Commitments and contingencies  Note 8Stockholders equity:Preferred stock ($0.01 par value; 5,000 shares authorized; none outstanding)Common stock ($0.01 par value; 75,000 shares authorized; 30,057 and 30,060 shares outstanding at September 24, 2010 and March 26, 2010)300300Additional paid-in capital254,648252,105Treasury stock, at cost(10,933)(10,374)Accumulated other comprehensive loss(1,653)(1,398)Accumulated deficit(192,133)(180,529)Total stockholders equity50,22960,104Total liabilities and stockholders equity$105,341$117,686 See accompanying notes to condensed consolidated financial statements   NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Statements of Operations and Comprehensive Loss(Unaudited  in thousands, except per share amounts)  Three Months EndedSix Months EndedSeptember 
24, 2010September
25, 2009September
24, 2010September
25, 2009Revenue:Product$16,741$14,420$26,728$30,285Service and other3,4895,3416,9838,986Total revenue20,23019,76133,71139,271Costs of revenue:Cost of product7,3057,53212,92714,889Cost of service and other3,0184,4266,1297,707Total cost of revenue10,32311,95819,05622,596Gross margin9,9077,80314,65516,675Operating expenses:Sales and marketing5,0234,6289,75610,020Research and development4,6154,7839,6549,408General and administrative3,1862,7185,9125,585Restructure and other costs (recoveries)(14)24Total operating expenses12,82412,11525,32225,037Loss from operations(2,917)(4,312)(10,667)(8,362)Interest income209412433888Interest expense(555)(598)(1,107)(1,162)Gain on extinguishment of debt555Other income (expense), net23300(58)228Loss before taxes(3,240)(4,198)(11,399)(7,853)Income tax provision (benefit)154(14)20544Net loss$(3,394)$(4,184)$(11,604)$(7,897)Basic and diluted  net loss per share$(0.11)$(0.14)$(0.39)$(0.27)Common and common equivalent shares, basic and diluted29,73729,24329,73129,152Condensed Consolidated Statements of Comprehensive Loss:Net loss$(3,394)$(4,184)$(11,604)$(7,897)Other comprehensive income (loss), net of taxes:Foreign currency translation adjustments(167)(244)(261)408Gross unrealized holding gains (losses) on available-for-sale securities143(11)97320Reclassification adjustments for gains included in net loss(20)(86)(90)(234)Comprehensive loss$(3,438)$(4,525)$(11,858)$(7,403) See accompanying notes to condensed consolidated financial statements   NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Statements of Cash Flows(Unaudited  in thousands)  Six Months EndedSeptember
24, 2010September 
25, 2009Cash and cash equivalents at beginning of period$4,953$15,589Cash flows from operating activities:Net loss(11,604)(7,897)Adjustments required to reconcile net loss to net cash used in operating activities:Depreciation, amortization, and accretion1,4061,811Stock-based compensation expense2,9132,730Gain on extinguishment of debt(555)Loss on disposition of property and equipment1973Provision for deferred income taxes222Interest earned on restricted cash(1)(6)Changes in assets and liabilities:Accounts receivable(99)(6,475)Inventories4601,306Prepaid expenses and other assets2,0491,829Accounts payable(71)2,831Accrued liabilities(2,495)(864)Net cash used in operating activities(7,201)(5,217)Cash flows from investing activities:Purchase of short-term investments(20,365)(32,932)Proceeds from sales and maturities of short-term investments29,85829,663Purchases of property and equipment(846)(703)Increase in restricted cash(1,637)Net cash provided by (used in) investing activities7,010(3,972)Cash flows from financing activities:Issuance of common stock42587Repurchase of common stock(561)(603)Payments under capital lease obligation(29)Repurchase of 33⁄4% convertible senior notes(1,875)Net cash used in financing activities(548)(1,891)Effect of exchange rate changes on cash(254)380Net decrease in cash and cash equivalents(993)(10,700)Cash and cash equivalents at end of period$3,960$4,889Other cash flow information:Cash paid during the period for:Interest$1,056$1,097Non-cash investing activities:Net unrealized gain on available-for-sale securities786Assets acquired under capital lease47  See accompanying notes to condensed consolidated financial statements   NETWORK EQUIPMENT TECHNOLOGIES, INC.Notes to Condensed Consolidated Financial Statements 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 26, 2010 was derived from the Companys audited consolidated financial statements. These financial statements should be read in conjunction with the March 26, 2010 audited consolidated financial statements and notes thereto. The results of operations for the three and six months ended September 24, 2010 are not necessarily indicative of the results to be expected for the fiscal year ending March 25, 2011 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 September 24, 2010, the results of operations for the three and six months ended September 24, 2010 and September 25, 2009, respectively and the cash flows for the six months ended September 24, 2010 and September 25, 2009, respectively. Through a contractual arrangement with the Company, CACI International Inc. (CACI) has certain rights to provide maintenance and other services to the Companys Federal customers. Under the current arrangement, both companies sell services for NET products, other than the Quintum Series products, and each company is responsible for various aspects of service delivery. CACI provides on-site repairs, NET provides spares logistics and bug fixes, and both companies provide training services. Under a revenue-sharing arrangement, revenue from maintenance and training services is shared between both companies, regardless of which company sells the services. The receipts from sales of these services are shared based on a pre-determined percentage, which is currently 37% for NET and 63% for CACI but may be higher or lower based upon the total annual amount of sales of these services. As such, 63% of NETs receipts that are subject to the agreement is remitted to CACI, and conversely, 37% of CACIs receipts that are subject to the agreement is remitted to the Company. The Company records amounts derived from sales by NET as gross revenue and records amounts remitted to NET by CACI as net revenue. This arrangement expires December 1, 2010, after which the Company intends to perform these services itself and to retain the revenue associated with these services. 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, and NX 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. Recently Issued Accounting Standards:In October 2009, the Financial Accounting Standards Board (FASB) issued new accounting guidance with respect to revenue recognition: ASU No. 2009-13, Topic 605  Multiple-Deliverable Revenue Arrangements;and ASU No. 2009-14, Topic 985  Certain Revenue Arrangements That Include Software Elements. When adopted, these accounting standards may be applied either prospectively or retrospectively. The Companys mandatory adoption date for this guidance will be March 26, 2011, the beginning of the Companys fiscal 2012. Early adoption is permitted. The Company has not determined when it will adopt this new guidance. The future effect, if any, of the adoption of this new guidance on the Companys consolidated financial statements will depend on whether the Company elects to apply these updates only prospectively or also retrospectively, and the nature of future revenue arrangements into which the Company may enter. 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 will adopt in the first quarter of fiscal 2012. Note 2.  Financial Instruments 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
September 24, 2010, usingBalance as of September 24,
2010Level 1Level 2Assets:U.S. government and municipalities(1)$33,446$33,446$Corporate notes and bonds(1)15,74015,740Other debt securities(1)14,95014,950Foreign debt issues(1)1,8861,886Foreign currency derivatives(2)7676Total$66,098$66,022$76Liabilities:Foreign currency derivatives(3)$66$$66Total$66$$66 (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. 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 prices that are based on inputs not quoted on active markets, but corroborated by market data. 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)September 
24, 2010March
26, 2010Purchased components$2,215$2,806Finished goods1,7021,571$3,917$4,377  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 $1.6 million and $1.8 million, respectively, at September 24, 2010 and March 26, 2010. 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 September 24, 2010, the Companys deposit on inventory held by Plexus was $4.2 million, of which $1.6 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, including inventory held by Plexus and the amount on deposit with Plexus. As a result of these evaluations, the Company recorded charges of $42,000 and $333,000, respectively, to cost of revenue in the three and six months ended September 24, 2010 and $957,000 and $1.3 million, respectively, for the comparable periods ended September 25, 2009. Note 4.  Loss Per Share The following table sets forth the computation of the numerator and denominator used in the computation of basic and diluted net loss per share: (in thousands, except per share amounts)Three Months EndedSix Months EndedSeptember 
24, 2010September
 25, 2009September 
24, 2010September
 25, 2009Numerator:Net loss$(3,394)$(4,184)$(11,604)$(7,897)Denominator-weighted average shares of common stock outstanding:Shares used to compute basic and diluted  net loss per share29,73729,24329,73129,152Basic and diluted net loss per share$(0.11)$(0.14)$(0.39)$(0.27)  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 and six months ended September 24, 2010 and September 25, 2009 as they are anti-dilutive and would therefore reduce the loss per share. The total amount of such anti-dilutive shares was 231,000 and 406,000 for the three months ended September 24, 2010 and September 25, 2009, respectively and 312,000 and 263,000 for the six months ended September 24, 2010 and September 25, 2009, respectively. At September 24, 2010, there are 770,000 shares of common stock issuable upon conversion of the 33⁄4% convertible senior notes and 753,000 shares of common stock issuable upon conversion of the 71⁄4% 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 and six months ended September 24, 2010. The net restructure cost (benefit) of ($14,000) and $24,000 for the three and six months ended September 25, 2009 related to unanticipated costs to exit the Companys former manufacturing facility and charges for employee separation costs. The liability for restructuring was $1.5 million at September 24, 2010 and consisted solely of accrued costs to exit the Companys former manufacturing facility. Changes in accrued amounts related to restructuring during fiscal 2011 were as follows: (in thousands)Restructure
AccrualBalance at March 26, 2010$2,119ProvisionPayments(670)Other (1)69Balance at September 24, 2010$1,518  (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.  The liability for restructuring balances at September 24, 2010 and March 26, 2010 include $233,000 and $822,000, respectively, classified as other long-term liabilities related to lease and other exit costs for the vacated facility, net of an estimated amount of sublease income. Note 6.  Warranty Accruals The Company warrants hardware product, generally for twelve months, and software, generally for 90 days. The software warranty entitles the customer to bug fixes but not software upgrades during the warranty period. The Companys methodology is to accrue warranty expense based on historical expense trends calculated as a percentage of product sales. Actual expenses are charged against the accrual in the period they are incurred. On a quarterly basis, the warranty accrual is analyzed for adequacy based on actual trends and subsequent adjustments are made as necessary. Components of the warranty accrual, which is included in accrued liabilities in the accompanying condensed consolidated balance sheets, were as follows: (in thousands)Six Months EndedSeptember
24, 2010September
 25, 2009Balance at beginning of period$69$82Charges to costs of revenue4225Charges to warranty accrual(49)(22)Other adjustments (1)12(6)Balance at end of period$74$79  (1) Adjustments result from changes in warranty cost estimates related to labor costs to repair products and frequency of warranty claims. Note 7.  Income Taxes The Company recorded tax provisions (benefits) of $154,000 and $205,000, and ($14,000) and $44,000, respectively, for the three and six months ended September 24, 2010 and September 25, 2009. All prior periods benefited from a U.S. federal refundable credit as a result of legislation which allows taxpayers to elect to forego bonus depreciation on certain additions of qualified eligible property and, in turn, claim a refundable credit for a portion of its unused alternative minimum tax and research credits. The Housing and Economic Recovery Act of 2008, signed into law in July 2008, applied to certain additions of qualified property placed in service from the period between April 2008 and December 2008. In February 2009, the American Recovery and Reinvestment Tax Act of 2009 was enacted and extended the period for eligible property additions for another year through December 31, 2009. The refundable credit ended December 31, 2009. The income tax provision included credit amounts of $40,000 and $52,000, respectively, for the three and six months ended September 25, 2009. Provisions for income tax are primarily related to the Companys international operations. The Company incurred additional, one-time, tax expense in the second quarter of fiscal 2011 relating to freight/duty refunds of $432,000 received by its United Kingdom subsidiary. Note 8.  Contractual Obligations and Commercial Contingencies 33⁄4% Convertible Senior Notes:  In December 2007, the Company issued $85.0 million of 33⁄4% convertible senior notes due December 15, 2014, in a private placement, of which $10.5 million remained outstanding at September 24, 2010. The notes 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. 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. In fiscal 2009 and 2010, the Company repurchased and retired a total of $74.5 million principal amount of the outstanding notes in privately negotiated transactions. There were no such repurchases in the six months ended September 24, 2010. In the six months ended September 25, 2009, the Company repurchased and retired $2.5 million principal amount of the outstanding notes in privately negotiated transactions. The Company recorded a net gain on this extinguishment of debt of $555,000, consisting of a $625,000 gain resulting from the repurchase of debt at below principal, partially offset by a $70,000 write-off of unamortized deferred financing costs related to the repurchased debt. The net gains on these transactions were recorded as non-operating income. 71⁄4% Redeemable Convertible Subordinated Debentures:In May 1989, the Company issued $75.0 million of 71⁄4% redeemable convertible subordinated debentures due May 15, 2014, of which $23.7 million remained outstanding at September 24, 2010. 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 certain amounts to the supplier for an additional, more advanced platform and an extended exclusive right to market. The agreement provides for two remaining payments totaling $2.5 million, due at separate future dates dependent upon the suppliers delivery of future enhancements of the advanced platform. The Company is obligated to pay royalties on sales of the licensed products, which began in the second half of fiscal 2007. Royalties for the three and six months ended September 24, 2010 were $98,000. There were no royalties for the three and six months ended September 25, 2009. 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 increased from $53.5 million at March 26, 2010 to $55.2 million at September 24, 2010. This increase resulted principally from the execution, in the second quarter of fiscal 2011, of a five-year extension of the Companys headquarters facility lease. The increase in contractual obligations caused by the lease extension was partially offset by ongoing interest and operating lease payments. The Companys restricted cash balance increased by $1.6 million during the second quarter of fiscal 2011, due to new deposit obligations relating to the facility lease extension. 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. Note 9.  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. 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 in the three and six months ended September 24, 2010 were none and 10,041 shares, respectively. Stock option exercises in the three and six months ended September 25, 2009 were 138,702 and 140,368 shares, 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 73,189 shares from employees in the three months ended September 24, 2010 for a total price of $235,000. In the six months ended September 24, 2010, the Company repurchased 136,792 shares from employees for a total price of $563,000. Stock Compensation Expense: Stock-based compensation expense for the three and six months ended September 24, 2010 and September 25, 2009, respectively, was as follows: (in thousands)Three Months EndedSix Months EndedSeptember
24, 2010September
25, 2009September
24, 2010September
25, 2009Cost of revenue$203$127$402$355Sales and marketing407259797917Research and development4963141,004773General and administrative361299710685$1,467$999$2,913$2,730  The fair value of the Companys stock option awards granted to employees was estimated using the following weighted-average assumptions: Three Months EndedSix Months EndedSeptember
24, 2010September
25, 2009September
24, 2010September
25, 2009Expected term, in years4.945.164.945.03Expected volatility74.88%68.27%73.24%68.81%Risk-free interest rate1.37%2.36%1.79%2.40%Expected dividendsWeighted-average fair value$1.96$3.54$2.74$3.23  Note 10.  Financial Instruments Fair Value Disclosure The estimated fair values of the Companys financial instruments at September 24, 2010 and March 26, 2010 were as follows: (in thousands)September
24, 2010March
26, 2010Carrying
AmountEstimated
Fair ValueCarrying
AmountEstimated
Fair ValueAssets:Short-term investments$66,022$66,022$75,508$75,508Liabilities:33⁄4% Convertible senior notes$10,500$8,190$10,500$7,98071⁄4% Redeemable convertible subordinated debentures$23,704$20,563$23,704$20,860  The gross unrealized holding gains (losses) on available-for-sale securities for short term investments recorded in accumulated other comprehensive loss are not material as of September 24, 2010 and March 26, 2010 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. See Note 2. Restricted cash:  The carrying value approximates fair value. Accrued liabilities:  The carrying value approximates fair value. Convertible debt:We have estimated the approximate fair value of these securities using the quoted market price or trade closest to September 24, 2010. 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 September 24, 2010 and March 26, 2010, the Company had outstanding foreign exchange forward contracts with aggregate notional amounts of $4.9 million and $5.1 million, respectively, which had remaining maturities of one month or less. As of September 24, 2010, 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 11.  Litigation 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.   ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 26, 2010. 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. Our Business Network Equipment Technologies, Inc. (NET), founded in 1983, develops and sells voice and data networking solutions that enable the integration and migration of existing networks to secure internet protocol (IP)-based communications. We have more than 25 years of operating history and a worldwide customer base that includes both government entities and enterprise customers. Our enterprise customer base includes large enterprises adopting unified communications and small- to mid-sized businesses implementing new Voice-over-IP (VoIP) technologies. Our government customers include a variety of federal and international agencies and organizations, including civilian and defense agencies and resellers to such entities. A new U.S. General Services Administration Schedule contract was issued to our Federal subsidiary in July 2010, providing an ongoing contracting vehicle for sales to the U.S. government. In addition to our direct sales capabilities, we are developing relationships with integrators, resellers and technology leaders 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, unified communications platforms, secure voice applications, and high-speed multiservice wide area networking transport networks. Our voice solutions include the VX Series and the Quintum Series of switching media gateways. Our multi-service solutions include the Promina platformand the NX Series high speed multi-service network exchange platform. 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 26, 2010. 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 EndedSix Months EndedSeptember
24, 2010September
25, 2009September
24, 2010September
25, 2009Percent of revenueProduct82.8%73.0%79.3%77.1%Service and other17.227.020.722.9Total revenue100.0100.0100.0100.0Product gross margin56.447.851.650.8Service and other gross margin13.517.112.214.2Total gross margin49.039.543.542.5Sales and marketing24.823.428.925.5Research and development22.824.228.624.0General and administrative15.613.817.614.2Restructure and other costs (recoveries)(0.1)0.1Total operating expenses63.261.375.163.8Loss from operations(14.2)(21.8)(31.6)(21.3)Interest expense, net(1.9)(0.9)(2.0)(0.7)Gain on extinguishment of debt1.4Other income (expense), net0.11.5(0.2)0.6Loss before taxes(16.0)(21.2)(33.8)(20.0)Income tax provision0.80.60.1Net loss(16.8)%(21.2)%(34.4)%(20.1)%  Overview and Highlights Note: Unless otherwise stated, all references to fiscal 2011 refer to the three and six months ended September 24, 2010; all references to fiscal 2010 or the prior fiscal year refer to the comparable prior year periods, that is, the three and six months ended September 25, 2009; and all comparative references, such as increases and decreases or higher and lower, refer to the current fiscal 2011 period as compared to the comparable fiscal 2010 period. · Total revenue in the second quarter was up slightly compared to the second quarter of the prior fiscal year, driven by a 16% increase in product revenue. As a result of a weak first quarter, however, total revenue in the first six months of fiscal 2011 was 14% lower than in the comparable prior year periods, with product revenue down 12%. The decline in total revenue for the first six months of fiscal 2011, compared to the comparable prior-year period, resulted principally from lower sales to government customers in the first quarter of fiscal 2011 compared to the first quarter of the prior fiscal year. · Our sales to the government sector continue to account for a majority of our revenue, but fluctuate from quarter to quarter.Revenue from government customers as a percentage of total revenue for the second quarter and the first six months of fiscal 2011 was 76.0% and 74.5%, respectively. For the comparable prior-year periods, revenue from government customers as a percentage of total revenue was 83.5% and 79.2%, respectively. Spending by government customers is dependent upon the size of budget allocations, the timely passage of the annual federal budget, and the timing of specific programs. In addition, government customers may purchase large quantities of equipment from us in a single quarter, often with orders totaling $2 to $5 million or more, and then make no purchases in other quarters, making quarterly comparisons difficult. For example, over the course of fiscal year 2010, we achieved quarterly revenue ranging from $84,000 to $6.2 million for NX1000 sales from a single government program. · Sales of our VoIP-based product lines increased in the first six months of fiscal 2011. Product revenue from our VX series was $6.1 million in the second quarter of fiscal 2011, more than triple the amount in the second quarter of fiscal 2010. The increase in revenues was due principally to greater VX series sales to commercial customers for UC implementations and to government customers for secure communications applications. For the first six months of fiscal 2011, product revenue from our VX series was $9.9 million, a 16% increase compared to the comparable prior-year period. Revenue from Tenor series products increased by 14.0% in the second quarter of fiscal 2011 and decreased by 14.3% in the first six months of fiscal 2011, compared to the comparable prior-year periods. Product revenue from enterprise customers for our VX series was up 61% for the first six months of fiscal 2011 compared to the comparable prior-year period. We have announced a new VoIP and unified communications platform, the UX Series. The first product in the UX Series, the UX2000, became generally available early in the third quarter of fiscal 2011. · Sales of our multi-service networking products declined from the prior year. On a combined basis, sales of our Promina and NX1000 products in the second quarter were up significantly compared to the first quarter but down 26% compared to the second quarter of fiscal 2010. For the first six months of fiscal 2011, combined sales of our Promina and NX1000 products were down 29% from the comparable prior-year period. The reduction in 2011 is primarily from lower sales of the NX1000, which are largely concentrated to a specific customer. Promina products, which are based on time division multiplexing, continue to perform well for certain applications and we have a large installed base, particularly in the Federal government. The NX1000 product is an extension of our Promina product line and allows Promina customers to add IP capabilities to their networks. Given the installed base for Promina and the addition of the NX1000 product, we expect to see orders for Promina and NX1000 products for the next few years, but at a declining rate. · 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, and spending by government customers fluctuates for the reasons noted above. The following table shows elements of our sector mix and our mix of product sales: (in thousands, except percentages)Three Months EndedSix Months EndedSeptember
24, 2010September
25, 2009September
24, 2010September
25, 2009Sector mix:Revenue from government customers$15,379$16,498$25,120$31,120% of total revenue76.0%83.5%74.5%79.2%Mix of product sales:Promina product revenue$6,202$3,706$9,505$9,431% of product revenue37.0%25.7%35.6%31.1%VoIP-based product revenue$8,613$4,182$14,361$13,714% of product revenue51.4%29.0%53.7%45.3%  · Expense levels were generally consistent with prior periods.Operating expense in the second quarter and first six months of fiscal 2011 increased 6% and 1%, respectively.The most significant factor contributing to the higher level of expense in fiscal 2011 were legal costs incurred for an internal investigation regarding compliance with U.S. export laws. The Company continues to monitor expenses closely. On a temporary basis, since the beginning of fiscal 2010, most of our domestic employees have taken a 7.5% salary reduction, with executives taking reductions of 10% to 15%. The salary reductions have been offset by grants of restricted stock. These salary reductions with offsetting grants of equity have reduced cash consumption, while having a neutral effect upon compensation expense. Revenue (in thousands, except percentages)Three Months EndedSix Months EndedSeptember
24, 2010September
25, 2009ChangeSeptember
24, 2010September
25, 2009ChangeProduct$16,741$14,42016.1%$26,728$30,285(11.7)%Service and other3,4895,341(34.7)6,9838,986(22.3)Total revenue$20,230$19,7612.4%$33,711$39,271(14.2)%  Total revenue increased in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010, as well as compared to the first quarter of fiscal 2011, driven by product revenue. For the first six months of fiscal 2011, total revenue was lower than in the comparable prior-year period, primarily due to low sales to government customers in the first quarter of fiscal 2011. Product revenue increased in the second quarter of fiscal 2011 over the comparable prior-year period principally due to increased sales of VX Series products to government customers offset by lower sales of multi-service networking products to government customers. For the first six months of fiscal 2011, product revenue declined principally due to reduced sales to government customers in the first quarter. Also, sales associated with the basic VoIP applications that were a large part of the traditional Quintum business have continued to decline as we shift our focus to more-advanced unified communications, Session Initiation Protocol (SIP) trunking, and other applications supported by our VX Series products. We expect our mix of product sales and our sector mix to fluctuate quarter to quarter, as our customers continue to move to IP-based communications. Spending by government customers is dependent on the size of budget allocations and, particularly in our fiscal third quarter, the timely passage of the annual federal budget. Sales to our government customers also fluctuate based upon the timing of specific government programs. Service and other revenue decreased in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010 because in the second quarter of fiscal 2010, we recognized $1.3 million of previously deferred service and other revenue. 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 EndedSix Months EndedSeptember
24, 2010September
25, 2009September
24, 2010September
25, 2009Product gross margin56.4%47.8%51.6%50.8%Service and other gross margin13.517.112.214.2Total gross margin49.0%39.5%43.5%42.5%  Total gross margin increased in fiscal 2011 principally as a result of higher product margins. Product margins increased in fiscal 2011 due to: · Freight/duty refunds of $432,000 received by our United Kingdom subsidiary in the second quarter of fiscal 2011 and credited to product cost of revenue. These refunds related to overpayments of duty tax for certain sales transactions which occurred over a period from 1995 to 1999. · Lower inventory reserves recorded in fiscal 2011. Inventory reserve charges for the second quarter and first six months of fiscal 2011 were $42,000 and $333,000, respectively. For the comparable prior year periods, inventory reserve charges, which principally related to reduced demand for our NX5010 product resulting from delays in government programs, were $957,000 and $1.3 million, respectively. · Absorption of manufacturing overhead was slightly improved in the second quarter of fiscal 2011 and declined slightly in the first six months of fiscal 2011, compared to the comparable prior-year periods, due to fluctuations in product revenues. Service and other gross margin was relatively unchanged in fiscal 2011. Service revenue and related cost of goods sold decreased in fiscal 2011, reflecting the recognition, in fiscal 2010, of revenues and costs relating to previously deferred service and other revenue. Operating Expenses (in thousands, except percentages)Three Months EndedSix Months EndedSeptember
24, 2010September
25, 2009ChangeSeptember
24, 2010September
25, 2009ChangeSales and marketing$5,023$4,6288.5%$9,756$10,020(2.6)%Research and development4,6154,783(3.5)9,6549,4082.6General and administrative3,1862,71817.25,9125,5855.9Restructure and other costs (recoveries)(14)(100.0)24(100.0)Total operating expenses$12,824$12,1155.9%$25,322$25,0371.1%  Total operating expenses in fiscal 2011 increased due principally to legal costs incurred for an internal investigation regarding compliance with U.S. export laws. Sales and marketing expense was higher in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010. The principal reasons for this increase were: · Employee compensation was higher by $208,000, reflecting: o An increase of $148,000 in stock compensation expense due largely to the timing of the award and vesting dates of stock grants used both to compensate employees for salary reductions and in lieu of cash merit awards. o An increase in direct payroll costs relating to new employees of $101,000. o Greater sales commissions, accounting for $53,000 of additional expense. o A reduction of $94,000 in compensation costs for consultants and temporary employees. · Costs for products deployed for sales and marketing purposes, such as those provided for use in Microsoft Training Centers, were higher by $94,000. · Travel and entertainment costs were higher by $47,000. · Other miscellaneous expenses, including allocations of shared expenses, were higher by $46,000. For the first six months of fiscal 2011, sales and marketing expense was lower than in the comparable fiscal 2010 period. The principal reasons for this decrease were as follows: · Employee compensation was lower by $531,000, reflecting: o An absence of employee separation costs. In the first quarter of fiscal 2010, we incurred employee separation costs of $700,000 in connection with the retirement of our former Federal sales executive. There were no similar charges in the first six months of fiscal 2011. o Sales commissions were $106,000 lower in the first six months of fiscal 2011 than in the comparable prior-year period, reflecting reduced bookings in the first quarter. o These reductions were offset by increased stock compensation expense and increased direct payroll costs, which together increased by $277,000 in the first six months of fiscal 2011. · Costs for products deployed for sales and marketing purposes were higher by $89,000. · Travel and entertainment costs were higher by $104,000. · Other costs were higher by $74,000. Research and development expense was slightly lower in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010. The principal reasons for this decrease were as follows. · Employee compensation was higher by $295,000, reflecting higher salary costs due to higher average headcount during the period, increased stock compensation expense due largely to the timing of the award and vesting dates of stock grants, and higher costs for consultants and temporary employees. · Engineering related expenses were lower by $316,000. The second quarter of fiscal 2010 included substantial costs associated with ramping up new product development, such as for parts and materials for prototypes. · Other costs, principally depreciation were lower by $147,000. Depreciation expense has declined as the value of assets reaching the end of their depreciation lives has exceeded the value of new assets acquired over the past 12 months. For the first six months of fiscal 2011, research and development expense was slightly higher than in the comparable fiscal 2010 period. The principal reasons for this increase were as follows: · Employee compensation was higher by $914,000, reflecting: o An increase of $397,000 in direct payroll costs, largely due to higher average headcount during the period. o An increase of $231,000 of stock compensation expense. o Higher costs for consultants and temporary employees, of approximately $286,000. · Engineering related expenses were lower by $376,000, principally because we incurred substantial costs associated with ramping up new product development in the second quarter of fiscal 2010. · Other costs, principally depreciation, were lower by $293,000. General and administrative expense was higher in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010. The principal reasons for this increase were as follows: · Legal fees incurred in the second quarter of fiscal 2011 for an internal investigation of our export-related activities, which is being performed by outside counsel. The increase in legal costs period-to-period was $802,000. · Outside consulting costs were lower by $231,000 due principally to lower audit fees. · Compensation costs were lower by $30,000. · Miscellaneous other costs that included bad debt, bank fees, accretion charges for our vacated facility and allocations of shared expenses, were lower by $72,000. For the first six months of fiscal 2011, general and administrative expense increased by $327,000. The principal reasons for this increase were as follows: · Legal fees incurred in the second quarter of fiscal 2010 for an internal investigation of our export-related activities, which is being performed by outside counsel. The increase in legal costs period-to-period was $862,000. · Outside consulting costs were lower by $219,000 due to lower audit fees. · Compensation costs, including direct pay and stock-based compensation, were lower by $128,000. · Miscellaneous other costs that included bad debt, bank fees, accretion charges for our vacated facility, and allocations of shared expenses, were lower by $188,000.  Non-Operating Items (in thousands, except percentages)Three Months EndedSix Months EndedSeptember
 24, 2010September
 25, 2009ChangeSeptember 24, 2010September
25, 2009ChangeInterest income$209$412(49.3)%$433$888(51.2)%Interest expense$(555)$(598)(7.2)$(1,107)$(1,162)(4.7)Gain on extinguishment of debt$$$$555(100.0)Other income (expense), net$23$300(92.3)$(58)$228(125.4)  Interest income was lower in fiscal 2011 due to lower average interest earned on investments, and, to a lesser extent, to lower average cash balances. Average cash balances were lower primarily due to the effect of operating losses in the full fiscal year 2010 and in the first six months of fiscal 2011. Interest expense was lower in fiscal 2011, reflecting the retirement of a portion of our outstanding debt through repurchases in fiscal 2010. In the first quarter of fiscal 2010 we repurchased and retired $2.5 million of the principal amount of our outstanding 33⁄4% convertible senior notes. We realized a net gain on this extinguishment of debt of $555,000, consisting of a $625,000 gain resulting from the repurchase of debt at below principal, partially offset by a $70,000 write-off of unamortized deferred financing costs related to the repurchased debt. The net gain on this transaction was recorded as non-operating income. Other expense, net, consisted of: (in thousands)Three Months EndedSix Months EndedSeptember 
 24, 2010September 25, 2009September 
 24, 2010September 25, 2009Gain (loss) on foreign exchange$3$192$(144)$(28)Realized gain on investments208690234Other22(4)22$23$300$(58)$228  Income Tax Provision Income tax provisions (benefits) were $154,000 and $205,000, and ($14,000) and $44,000, respectively, for the three and six months ended September 24, 2010 and September 25, 2009. All prior periods benefited from a U.S. federal refundable credit as a result of legislation which allows taxpayers to elect to forego bonus depreciation on certain additions of qualified eligible property and, in return, to claim a refundable credit for a portion of its unused alternative minimum tax and research credits. The Housing and Economic Recovery Act of 2008, signed into law in July 2008, applied to certain additions of qualified property placed in service from the period between April 2008 and December 2008. In February 2009, the American Recovery and Reinvestment Tax Act of 2009 was enacted and extended the period for eligible property additions for another year through December 31, 2009. The refundable credit ended December 31, 2009. The income tax provision included credit amounts of $40,000 and $52,000, respectively, for the three and six months ended September 25, 2009. Provisions for income tax are primarily related to our international operations. We incurred additional, one-time, tax expense in the second quarter of fiscal 2011 relating to freight/duty refunds of $432,000 received by our United Kingdom subsidiary. Liquidity and Capital Resources Historically, our primary sources of liquidity and capital resources have been our cash balances, cash provided by operating activities, debt financings, and committed credit lines. Cash Balances:As of September 24, 2010, cash and cash equivalents, short-term investments and restricted cash were $72.2 million, as compared to $81.0 million as of March 26, 2010. At September 24, 2010, these amounts were invested 54.9% in U.S. government and municipal agency investments and cash equivalents, primarily money market funds. Cash Flows from Operating Activities:Net cash used in operating activities was $7.2 million in the first six months of fiscal 2011 compared to $5.2 million in the first six months of fiscal 2010. The increase in net cash used in operating activities resulted principally from the difference in net loss, which was $3.7 million higher in fiscal 2011, and by changes in asset and liability balances, particularly accounts receivable. The effect upon cash of changes in accounts receivable balances was a $6.4 million reduction in cash used in operating activities. Collections on accounts receivable were higher in the first six months of fiscal 2011 than in the same period in fiscal 2010 principally because revenues in the fourth quarter of fiscal 2010 were higher than in the fourth quarter of fiscal 2009. Changes in other balance sheet items were collectively responsible for a $5.2 million increase in cash used in operating activities. Changes in depreciation, amortization and accretion, stock-based compensation expense and gain on extinguishment of debt, collectively did not have a significant effect upon cash used in operating activities. Cash Flows from Investing Activities:Net cash provided by (used in) investing activities was $7.0 million in the first six months of fiscal 2011 compared to ($4.0 million) in the comparable prior-year period. 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 $9.5 million in the first six months of fiscal 2011, but used net cash of $3.3 million in the comparable prior-year period. Cash Flows from Financing Activities:Net cash used in financing activities was $548,000 in the first six months of fiscal 2011 compared to $1.9 million in the comparable prior-year period. The principal difference between the two periods was that, in the first six months of fiscal 2010, we paid $1.9 million to repurchase a portion of our outstanding 33⁄4 convertible senior notes. Non-cash Investing Activities:Our primary non-cash investing activity in the first six months of fiscal 2011 was the acquisition of assets under capital lease in the amount of $47,000. In the comparable prior-year period, the unrealized gain on available-for-sale securities was $86,000. Contractual Obligations and Commercial Commitments:Our contractual obligations consist of facilities leases with non-cancellable terms in excess of one year, capital leases and a note payable for certain office equipment, principal and interest on our 33⁄4% convertible senior notes and our 71⁄4% redeemable convertible subordinated debentures, and a license and development agreement with a third party to develop new products. Our contractual obligations and contingencies increased $1.7 million from March 26, 2010. This increase resulted principally from the execution, in the second quarter of fiscal 2011, of a five-year extension of our headquarters facility lease. The increase in contractual obligations caused by the lease extension was partially offset by ongoing operating lease payments and interest payments on the outstanding 33⁄4% convertible senior notes issued in December 2007 and 71⁄4% redeemable convertible subordinated debentures issued in May 1989. The following table provides a summary of our contractual obligations and other commercial commitments as of September 24, 2010: Contractual Obligations
(in thousands)Total20112012
to
20132014
to
2015After
2015Long-term debt$34,204$$$34,204$Interest on long-term debt8,6461,0564,2253,365Operating leases12,1742,0145,3162,5832,261Capital leases161351197Total contractual obligations$55,185$3,105$9,660$40,159$2,261  Apart from the extension of our headquarters facility lease, there was no significant change to our other contractual obligations in the three months ended September 24, 2010. We have a commitment to pay a total of $2.5 million to a third-party technology supplier upon receipt of future deliverables. We have a long-term income tax liability for uncertain tax positions amounting to $633,000 at September 24, 2010. 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 Corp. (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. At September 24, 2010, Plexus held inventory related to our products. Our deposit relating to this inventory was $4.2 million at September 24, 2010 and reserves relating to this deposit were $1.6 million. 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 have provided preliminary disclosures regarding these transactions to the U.S. Department of Commerce and the U.S. Department of Treasury, are 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 we have violated U.S. export laws, 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, debarment from government business, or loss of export privileges. 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. At this time, we 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, we have not provided any 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, acquisitions, 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. ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following are the material changes for the six months ended September 24, 2010 from the information reported under Part II, Item 7A of our Form 10-K for the fiscal year ended March 26, 2010: A 10% change in market interest rates would change the fair value of our investment portfolio by $33,000, as compared to a change of $61,000 as of March 26, 2010. A 10% change in the foreign currency rates affecting our foreign exchange contracts as of their September 24, 2010 levels would change the fair value of the contracts by $490,000, as compared to a change of $510,000 for the contracts as of March 26, 2010. The fair market values of our 33⁄4% convertible senior notes and our 71⁄4% 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 33⁄4% convertible senior notes was $8.2 million as of September 24, 2010 and $8.0 million as of March 26, 2010. The fair value of the 71⁄4% redeemable convertible subordinated debentures was $20.6 million as of September 24, 2010 and $20.9 million as of March 26, 2010.  ITEM 4.  CONTROLS AND PROCEDURES 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 September 24, 2010. No changes in our internal control over financial reporting occurred during the quarter ended September 24, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 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  ITEM 1. LEGAL PROCEEDINGS  We are 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 us 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 our business, results of operations and financial position. A subsidiary of ours, 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 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’s 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, which were originally scheduled for October, 2010, have been postponed to January, 2012. We have not accrued any amounts related to the claims, as we believe that a negative outcome is not probable.  ITEM 1A. RISK FACTORS  Our business is subject to the risks and uncertainties described in our most recent annual report on Form 10-K, as updated and supplemented below. 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, our most recently filed Form 10-Q and the following: We are conducting an internal investigation regarding our compliance with U.S. export laws. We are subject to U.S. laws and regulations governing international trade and exports, such as trade sanctions against embargoed countries, International Traffic in Arms Regulations (ITAR), and Export Administration Regulations (EAR), including, but not limited to the export licensing requirements thereunder. The Company has learned that some 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. A determination by the U.S. government that we have failed to comply with one or more export control laws or trade sanctions, could result in civil or criminal penalties, including the imposition of significant fines, denial of export privileges, loss of revenues from certain customers, and debarment from participation in U.S. government contracts. Any one or more of these sanctions could have a material adverse effect on our business, financial condition and results of operations.  ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS (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 September 24, 2010: Fiscal PeriodTotal Number of Shares Purchased (1)Average Price Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value of Shares That May Yet Be Purchased Under the Publicly Announced Plans or ProgramsJune 26  July 23, 2010$July 24  August 20, 201073,189$3.21$August 21  September 24, 2010$73,189$3.21$  (1) 73,189 shares were acquired directly from employees as payment of tax withholding obligations upon vesting of restricted stock awards.  ITEM 3.  DEFAULTS UPON SENIOR SECURITIES Not applicable.   ITEM 5.  OTHER INFORMATION Not applicable.  ITEM 6.  EXHIBITS  (a) Exhibits 10.48Amendment to Lease between Ardenwood Corporate Park Associates and Network Equipment Technologies, Inc. dated August 11, 2010, as corrected.31.1Rule 13a-14(a) Certification (CEO).31.2Rule 13a-14(a) Certification (Chief Accounting Officer).32.1Section 1350 Certification (CEO).32.2Section 1350 Certification (Chief Accounting Officer).   SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.  Dated:  November 2, 2010 NETWORK EQUIPMENT
TECHNOLOGIES, INC.    /s/ C . NICHOLAS KEATING, JR. C. Nicholas Keating, Jr.
President and Chief Executive Officer   /s/ KAREN CARTE Karen Carte
Vice President and Chief Accounting Officer 
(principal accounting officer)