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 December 25, 2009. 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 January 22, 2010 was 30,048,000.    NETWORK EQUIPMENT TECHNOLOGIES, INC. INDEX PART I.  FINANCIAL INFORMATIONItem 1.  Financial StatementsCondensed Consolidated Balance Sheets at December 25, 2009 and March 27, 2009Condensed Consolidated Statements of Operations and Comprehensive Loss  Three and Nine Months Ended December 25, 2009 and December 26, 2008Condensed Consolidated Statements of Cash Flows  Nine Months Ended December 25, 2009 and December 26, 2008Notes 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 4.  Submission of Matters to a Vote of Security HoldersItem 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)  December
25, 2009March
27, 2009Current assets:Cash and cash equivalents$5,086$15,589Short-term investments80,01481,432Restricted cash1,2291,154Accounts receivable, net of allowances of $262 at December 25, 2009 and $351 at March 27, 20098,6697,091Inventories6,6127,364Prepaid expenses and other assets7,22010,073Total current assets108,830122,703Property and equipment, net5,3246,505Other assets3,7474,225Total assets$117,901$133,433Current liabilities:Accounts payable$5,686$4,257Accrued liabilities12,97115,084Total current liabilities18,65719,341Long-term liabilities:33⁄4% convertible senior notes10,50013,00071⁄4% redeemable convertible subordinated debentures23,70423,704Capital lease obligation, less current portion83Other long-term liabilities2,7424,568Total long-term liabilities37,02941,272Commitments and contingencies  Note 9Stockholders equity:Preferred stock ($0.01 par value; 5,000 shares authorized; none outstanding)Common stock ($0.01 par value; 75,000 shares authorized; 30,034 and 29,193 shares outstanding at December 25, 2009 and March 27, 2009)300291Additional paid-in capital250,618245,654Treasury stock, at cost(10,102)(9,177)Accumulated other comprehensive loss(1,219)(1,262)Accumulated deficit(177,382)(162,686)Total stockholders equity62,21572,820Total liabilities and stockholders equity$117,901$133,433 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 EndedNine Months EndedDecember
25, 2009December
26, 2008December
25, 2009December
 26, 2008Revenue:Product$12,550$15,304$42,835$42,001Service and other3,7733,66812,75911,060Total revenue16,32318,97255,59453,061Costs of revenue:Cost of product6,5786,84121,46725,789Cost of service and other3,2093,52910,91611,006Impairment of long-lived assets9,741Total cost of revenue9,78710,37032,38346,536Gross margin6,5368,60223,2116,525Operating expenses:Sales and marketing4,6685,15914,68816,599Research and development5,0535,12314,46117,251General and administrative3,5832,8729,1689,885Restructure and other (recoveries) costs(7)1,420171,814Impairment of goodwill and long-lived assets34,197Total operating expenses13,29714,57438,33479,746Loss from operations(6,761)(5,972)(15,123)(73,221)Interest income3308681,2183,073Interest expense(555)(833)(1,717)(3,285)Gain on extinguishment of debt18,77655528,927Other income, net186322414299Income (loss) before taxes(6,800)13,161(14,653)(44,207)Income tax provision (benefit)(1)614315Net income (loss)$(6,799)$13,100$(14,696)$(44,222)Basic net income (loss) per share$(0.23)$0.45$(0.51)$(1.53)Diluted net income (loss) per share$(0.23)$0.42$(0.51)$(1.53)Common and common equivalent shares:Basic29,28028,84729,10128,856Diluted29,28032,50029,10128,856Condensed Consolidated Statements of Comprehensive Income (Loss):Net income (loss)$(6,799)$13,100$(14,696)$(44,222)Other comprehensive income (loss), net of taxes:Foreign currency translation adjustments(217)(1,468)191(1,864)Gross unrealized holding gains (losses) on available-for-sale securities(70)1,938250428Reclassification adjustments for gains included in net income (loss)(164)(293)(398)(475)Comprehensive income (loss)$(7,250)$13,277$(14,653)$(46,133) See accompanying notes to condensed consolidated financial statements     NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Statements of Cash Flows(Unaudited  in thousands)  Nine Months EndedDecember
25, 2009December
26, 2008Cash and cash equivalents at beginning of period$15,589$44,246Cash flows from operating activities:Net loss(14,696)(44,222)Adjustments required to reconcile net loss to net cash used in operating activities:Depreciation, amortization, and accretion2,5584,675Impairment of goodwill and long-lived assets43,938Stock-based compensation expense4,4653,484Gain on extinguishment of debt(555)(28,927)Loss on disposition of property and equipment834Interest earned on restricted cash(7)Changes in assets and liabilities:Accounts receivable(1,578)11,165Inventories7522,033Prepaid expenses and other assets3,089(2,466)Accounts payable1,434(3,850)Accrued liabilities(3,986)(4,140)Net cash used in operating activities(8,441)(18,306)Cash flows from investing activities:Purchase of short-term investments(41,841)(48,264)Proceeds from sales and maturities of short-term investments43,11180,376Purchases of property and equipment(1,223)(826)Increase in restricted cash(68)(1,150)Net cash provided by (used in) investing activities(21)30,136Cash flows from financing activities:Issuance of common stock60746Repurchase of common stock(929)(1,254)Payments under capital lease obligation(9)Repurchase of 33⁄4% convertible senior notes(1,875)(41,176)Repurchase of 71⁄4% redeemable convertible subordinated debentures(640)Net cash used in financing activities(2,206)(43,024)Effect of exchange rate changes on cash165(1,865)Net decrease in cash and cash equivalents(10,503)(33,059)Cash and cash equivalents at end of period$5,086$11,187Other cash flow information:Cash paid during the period for:Interest$2,158$4,478Non-cash investing and financing activities:Net unrealized loss on available-for-sale securities(148)(47)Assets acquired under capital lease145  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 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 27, 2009 was derived from the Companys audited consolidated financial statements. These financial statements should be read in conjunction with the March 27, 2009 audited consolidated financial statements and notes thereto. The results of operations for the three and nine months ended December 25, 2009 are not necessarily indicative of the results to be expected for the fiscal year ending March 26, 2010 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 December 25, 2009, the results of operations for the three and nine months ended December 25, 2009 and December 26, 2008, respectively and the cash flows for the nine months ended December 25, 2009 and December 26, 2008, 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 maintenance support for first-level calls and 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 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. The Company has evaluated subsequent events through February 2, 2010, the date on which the financial statements presented herein were issued as part of this Quarterly Report on Form 10-Q, and not beyond that date. Recently Issued Accounting Standards:In October 2009, the FASB issued new accounting guidance with respect to revenue recognition for arrangements with multiple deliverables and also with respect to accounting for 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 June 2008, the FASB issued accounting guidance requiring participating securities such as unvested restricted stock grants containing nonforfeitable rights to receive dividends, whether paid or unpaid, to be included in the computation of earnings per share pursuant to the two-class method. The guidance also requires all prior-period earnings per share data presented to be adjusted retrospectively. The Company adopted the new guidance in the first quarter of fiscal 2010. The adoption did not have a material impact on current or prior period consolidated financial statements. 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
December 25, 2009 UsingBalance as of December 25, 2009Level 1Level 2Level 3Assets:U.S. government and municipalities(1)$68,560$68,560$$Corporate notes and bonds(1)5,0563,5551,501Other debt securities(1)5,8825,398484Foreign debt issues(1)516516Foreign currency derivatives(2)2727Total$80,041$78,029$2,012$Liabilities:Foreign currency derivatives(3)$87$$87$Total$87$$87$ (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 comprehensive income (loss) and were not material for any period presented. Note 3. Inventories Inventories consisted of the following: (in thousands)December
25, 2009March
27, 2009Purchased components$5,111$5,791Finished goods1,5011,573$6,612$7,364  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 December 25, 2009, the Companys deposit on inventory held by Plexus was $5.1 million, of which $2.0 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 $371,000 and $1.7 million, respectively, to cost of revenue in the three and nine months ended December 25, 2009, and $700,000 and $5.0 million, respectively, for the comparable periods ended December 26, 2008. Note 4.  Income (Loss) Per Share The following table sets forth the computation of the numerator and denominator used in the computation of basic and diluted net income (loss) per share: (in thousands, except per share amounts)Three Months EndedNine Months EndedDecember
25, 2009December
 26, 2008December
25, 2009December
 26, 2008Numerator:Net income (loss)$(6,799)$13,100$(14,696)$(44,222)Effect of reduced interest expense assuming conversion of convertible senior notes476Net income (loss) used to compute diluted net income(loss) per share(6,799)13,576(14,696)(44,222)Denominator-weighted average shares of common stock outstanding:Shares used to compute basic net income (loss) per share29,28028,84729,10128,856Effect of dilutive common stock equivalents from stock-based compensation29Effect of dilutive common stock issuable upon conversion of convertible senior notes3,413Effect of dilutive contingently issuable shares211Shares used to compute diluted net income (loss) per share29,28032,50029,10128,856Basic net income (loss) per share$(0.23)$0.45$(0.51)$(1.53)Diluted net income (loss) per share$(0.23)$0.42$(0.51)$(1.53)  The denominator for basic 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 nine months ended December 25, 2009 and the nine months ended December 26, 2008 as they are anti-dilutive and would therefore reduce the loss per share. The total amount of such anti-dilutive shares was 282,000 for the three months ended December 25, 2009 and 279,000 and 102,000 for the nine months ended December 25, 2009 and December 26, 2008, respectively. At December 25, 2009, 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 the three and nine months ended December 25, 2009 and the nine months ended December 26, 2008, 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 The net restructure cost (recovery) of ($7,000) and $17,000, respectively, for the three and nine months ended December 25, 2009 relates to net charges and recoveries for employee separation costs. The net restructure cost of $1.4 million and $1.8 million, respectively, for the three and nine months ended December 26, 2008 relate to unanticipated costs to exit the Companys former manufacturing facility and charges for employee separation costs. The liability for restructuring was $2.5 million at December 25, 2009. Components of accrued restructure costs and changes in accrued amounts related to restructuring during fiscal 2010 are as follows: (in thousands)Employee Separation Costs & OtherFacility
Exit Costs & OtherTotalBalance at March 27, 2009$149$3,301$3,450Provision18(1)17Payments(63)(1,045)(1,108)Other (1)152152Balance at December 25, 2009$104$2,407$2,511  (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 December 25, 2009 and March 27, 2009 include $1.1 million and $1.9 million, 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.  License and Development Agreement In October 2005, the Company entered into 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. Each party agreed to perform development and other activities to bring new products to market, and the Company obtained certain rights to market these products. Under the agreement and subsequent amendments, the Company has paid $5.5 million in license and development fees and agreed to pay an additional $2.5 million at future dates dependent upon the suppliers delivery of future enhancements. The Company capitalized the amounts paid in other assets in the accompanying condensed consolidated balance sheets, and began amortizing these amounts in the second half of fiscal 2007 concurrent with the sale of the initial platform. In the second quarter of fiscal 2009 the Company performed an impairment analysis and determined the fair value of the license and development agreement and related other assets to be zero. Accordingly, the Company recorded an impairment charge of $3.7 million in the second quarter of fiscal 2009, representing the full net book value of the license and development agreement and other related assets. As a result of this impairment charge, there will be no future amortization expense relating to the amounts already paid under the license and development agreement. Amortization of $422,000 was recorded for the nine months ended December 26, 2008. Per the terms of the license and development agreement, as amended, the Company is obligated to pay royalties on sales of the products, which began in the second half of fiscal 2007. There were no royalties for the three and nine months ended December 25, 2009. These royalties totaled $0 and $93,000, respectively, for the three and nine months ended December 26, 2008. The supplier also serves as a reseller of the platform, and the parties have made occasional purchases from and sales to each other of inventory components and pre-production units. In the three and nine month periods ended December 25, 2009, the Company invoiced the supplier $13,000 and $32,000, respectively, and there were no purchase transactions. The Company invoiced the supplier $0 and $504,000, respectively, in the three and nine months ended December 26, 2008. No purchase transactions occurred during the three and nine months ended December 26, 2008. At December 25, 2009, no amounts were due to the supplier and $13,000 was due from the supplier. Note 7.  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)Nine Months EndedDecember
25, 2009December
 26, 2008Balance at beginning of period$82$98Charges to cost of goods sold3719Charges to warranty accrual(42)(39)Other adjustments (1)(4)Balance at end of period$73$78  (1) Adjustments result from changes in warranty cost estimates related to labor costs to repair products and frequency of warranty claims. Note 8.  Income Taxes The Company recorded tax provisions (benefits) of ($1,000) and $43,000, respectively, for the three and nine months ended December 25, 2009, and $61,000 and $15,000, respectively, for the three and nine months ended December 26, 2008. All 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 benefits recorded as a result of the credit amounted to $24,000 and $76,000, respectively, for the three and nine months ended December 25, 2009, and $23,000 and $114,000, respectively, for the three and nine months ended December 26, 2008. Provisions for income tax are primarily related to the Companys international operations. Note 9.  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 December 25, 2009. 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 the nine months ended December 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. In the nine months ended December 26, 2008, the Company repurchased and retired $72.0 million principal amount of the outstanding notes in privately negotiated transactions. The Company recorded a net gain on extinguishment of debt of $28.6 million, consisting of a $30.8 million gain resulting from the repurchase of debt at below principal, partially offset by a $2.2 million 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 December 25, 2009. 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. In the nine months ended December 26, 2008, the Company repurchased and retired $1.0 million principal amount of the outstanding debentures in a privately negotiated transaction. The Company recorded a net gain on this extinguishment of debt of $353,000, consisting of a $360,000 gain resulting from the repurchase of debt at below principal, partially offset by a $7,000 write-off of unamortized deferred financing costs related to the repurchased debt. The net gain on this transaction was recorded as non-operating income. Equipment Financing:  In the third quarter of fiscal 2010, the Company acquired certain office equipment through an agreement classified as a capital lease and also through a note payable. The cost of equipment financed by the capital lease and by the note payable was $145,000 and $141,000, respectively. The terms of both the capital lease agreement and the note payable are three years. The capital lease agreement includes a bargain purchase option which the Company may exercise at the end of the lease term. The equipment financed by the capital lease and the note payable is included in the condensed balance sheets as property and equipment, net. Amortization of assets under capital lease is included in depreciation expense. Accumulated amortization of assets under capital lease was none at December 25, 2009 and March 27, 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. In the third quarter of fiscal 2009, the Company settled certain patent lawsuits filed against Quintum before the acquisition of Quintum by the Company. Prior to and in connection with the settlement, the Company incurred a total of $3.2 million of legal expense, subject to indemnification and reimbursement under an escrow established as part of the acquisition agreement. A portion of the escrow is in cash and a portion is in Company stock, which for purposes of satisfying escrow claims, is valued at $11.83 per share (the price used to determine the number of shares paid in the acquisition of Quintum). At December 25, 2009, the Company has been reimbursed from the escrow, in cash and stock, for $1.4 million of legal expense and has pending escrow claims for an additional $1.8 million of legal expense. To the extent a claim is satisfied in Company stock and the Companys stock price at such time is below $11.83 per share, an expense is recorded for the price difference. In the three months and nine months ended December 25, 2009, the Company recorded charges of $230,000 and $546,000, respectively, relating to such price differences. At December 25, 2009, the Company had accrued $601,000 for price differences relating to unsettled indemnified claims, which, upon settlement will be adjusted to reflect the Companys stock price at that time. If the stock price is lower than at the expense accrual date, additional expense will be recorded; and if the stock price is higher than at the expense accrual date, the amounts accrued will be reduced. The Companys other contractual obligations and contingencies decreased $8.3 million from March 27, 2009 primarily due to ongoing operating lease payments and the repurchase and retirement, in May 2009, of $2.5 million in principal amount of the outstanding 33⁄4% convertible senior notes issued by the Company in December 2007. This decrease in other contractual obligations and contingencies was net of an increase of $286,000 in new capital lease and equipment loan obligations. Note 10.  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 its 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 nine months ended December 25, 2009 were 3,229 and 143,597 shares, respectively. Stock option exercises in the three and nine months ended December 26, 2008 were none and 11,309, respectively. Restricted stock awards granted under the equity plans are independent of option grants and are subject to restrictions. Awards, 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. 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 74,935 shares from employees in the three months ended December 25, 2009 for a total price of $327,000. In the nine months ended December 25, 2009, the Company repurchased 202,243 shares from employees for a total price of $929,000. The Company repurchased 26,755 shares from employees in the three months ended December 26, 2008 for a total price of $224,000. In the nine months ended December 26, 2008, the Company repurchased 73,621 shares from employees for a total price of $647,000.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. In September 2009, the Company completed an offer to exchange certain employee stock options issued under the 2008 Equity Incentive Plan, the 1993 Stock Option Plan and the 1997 Stock Option Program (the Offer to Exchange). Certain previously granted options were exchanged for restricted shares of the Companys common stock. Options for an aggregate of 923,844 shares of the Companys common stock were exchanged for an aggregate of 256,034 restricted shares. The number of restricted shares issued under the Offer to Exchange was based on ratios designed to equalize the value of stock options exchanged with that of restricted shares issued. Restricted shares issued under the Offer to Exchange were issued and outstanding upon grant, but are subject to vesting over approximately two years following the date of grant. The Company did not incur non-cash stock compensation expense in connection with the Offer to Exchange as the fair value of the stock options exchanged was equivalent to the fair value of the restricted shares awarded. Stock Compensation Expense: Stock-based compensation expense for the three and nine months ended December 25, 2009 and December 26, 2008 was as follows: (in thousands)Three Months EndedNine Months EndedDecember
 25, 2009December
 26, 2008December
 25, 2009December
 26, 2008Cost of revenue$188$156$543$451Sales and marketing3923121,309962Research and development4342771,207824General and administrative7213521,4061,247$1,735$1,097$4,465$3,484  The fair value of the Companys stock option awards granted to employees was estimated using the following weighted-average assumptions: Three Months EndedNine Months EndedDecember
25, 2009December
26, 2008December
 25, 2009December
 26, 2008Expected term, in years5.165.145.045.14Expected volatility71.40%67.49%68.93%60.47%Risk-free interest rate2.57%1.51%2.41%3.23%Expected dividendsWeighted average fair value$3.18$1.59$3.22$2.32  Note 11.  Stock Repurchase Plan In February 2008, the Board of Directors approved a stock repurchase plan for a period of up to twenty-four months. The Company first repurchased shares under the 2008 program in fiscal 2009. A total of 258,000 shares were repurchased under the 2008 program in fiscal 2009 at an average price of $3.90 per share for a total price of $1.0 million. There were no repurchases of shares under this program in the three and nine months ended December 25, 2009. The Company has repurchased shares from employees in fiscal 2010 to satisfy withholding-tax obligations arising from the vesting of restricted stock awards, as described in Note 10. Note 12.  Financial Instruments Fair Value Disclosure The estimated fair values of the Companys financial instruments at December 25, 2009 and March 27, 2009 were as follows: (in thousands)December
25, 2009March
27, 2009Carrying
AmountEstimated
Fair ValueCarrying
AmountEstimated
Fair ValueAssets:Short-term investments$80,014$80,014$81,432$81,432Liabilities:33⁄4% Convertible senior notes$10,500$7,980$13,000$7,80071⁄4% Redeemable convertible subordinated debentures$23,704$20,860$23,704$15,882  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 December 25, 2009. 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 (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 December 25, 2009 and March 27, 2009, the Company had outstanding foreign exchange forward contracts with aggregate notional amounts of $4.9 million and $5.6 million, respectively, which had remaining maturities of one month or less. As of December 25, 2009, 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 for foreign exchange contracts are not material. Note 13.  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 us from selling one or more products at all or in particular ways. Were unfavorable final outcomes to occur, there exists the possibility of 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 27, 2009. 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 (UC) and small- to mid-sized businesses (SMBs) 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. 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 WAN transport networks. Our voice solutions include the VX Series and the Quintum Series of switching media gateways. Our multi-service solutions include the Promina, NX1000 and NX5010 platforms. 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, 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. Through a contractual arrangement with NET, CACI International Inc. (CACI) has certain rights to provide maintenance and other services to our 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 maintenance support for first-level calls and 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 us 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 our 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 us. We record amounts derived from sales by us as gross revenue and we record amounts remitted to us by CACI as net revenue. This arrangement expires December 1, 2010, after which we intend to perform these services ourselves and to retain the revenue associated with these services. Revenue on our sales through resellers is recognized upon transfer of title to the reseller. Many of the sales to our resellers are based upon firm commitments from their end customer; as a result, these resellers carry little or no NET stock. For our Promina, VX, and NX products, NETs customers do not have the right to return the equipment. For our Quintum product line, our customers are subject to agreements allowing for limited rights of return and price protection. Accordingly, revenues are reduced for our 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. Other than the items discussed above, 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 27, 2009. Recent Accounting Pronouncements See Note 1 of our Notes to Condensed Consolidated Financial Statements for recent accounting pronouncements, including the expected dates of adoptions 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 EndedNine Months EndedDecember
25, 2009December
26, 2008December
25, 2009December
26, 2008Percent of revenueProduct76.9%80.7%77.0%79.2%Service and other23.119.323.020.8Total revenue100.0100.0100.0100.0Product gross margin47.655.349.915.4Service and other gross margin14.93.814.40.5Total gross margin40.045.341.812.3Sales and marketing28.527.226.431.3Research and development31.027.026.032.5General and administrative22.015.116.518.6Restructure and other costs7.53.4Impairment of goodwill and long-lived assets64.4Total operating expenses81.576.868.9150.3Loss from operations(41.5)(31.5)(27.1)(138.0)Interest income (expense), net(1.3)0.2(0.9)(0.4)Gain on extinguishment of debt99.01.054.5Other income (expense), net1.11.70.70.6Income (loss) before taxes(41.7)69.4(26.3)(83.3)Income tax provision (benefit)0.10.30.1Net income (loss)(41.7)%69.0%(26.4)%(83.3)%  Overview and Highlights Note: Unless otherwise stated, all references to fiscal 2010 refer to the three and nine months ended December 25, 2009; all references to fiscal 2009 or the prior fiscal year refer to the comparable prior year periods, that is, the three and nine months ended December 26, 2008; and all comparative references, such as increases and decreases or higher and lower, refer to the current fiscal 2010 periods as compared to the comparable fiscal 2009 periods. · Total revenue was down 14% in the third quarter but up 5% in the first nine months of fiscal 2010. The decline in the third quarter was due primarily to lower sales to Federal Government customers, offset by a slight increase in revenue from commercial customers. The increase in the first nine months was due to greater product revenue from government customers and to $1.5 million of externally funded research and development revenue, recognized in the second quarter upon achievement of certain milestones. The funded research and development consisted of $1.3 million of service and other revenue and $239,000 of product revenue. · Our sales to the government sector continue to account for a majority of our revenue, but fluctuate from quarter to quarter based upon the timing of orders.As a percentage of total revenue, revenue from government customers was 73.6% and 77.6%, respectively, in the third quarter and first nine months of fiscal 2010 compared to 80.5% and 73.1% in the prior-year periods. 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. In the second quarter of fiscal 2010, we achieved revenue of $5.7 million for NX1000 sales from a single government program. · Sales of IP-based platforms grew 6% and 24%, respectively, in the third quarter and first nine months of fiscal 2010. The NX Series, our IP-enabled multi-service platform, is an extension of our Promina product line. Our VX Series is a VoIP and unified communications platform with advanced network control and security features. In addition to secure voice applications for the government, the VX Series platform provides enterprise customers with telephony integration for unified communications and unified messaging. Our Quintum Tenor platform provides the basic functionality of a VoIP gateway, along with other features. VoIP platform revenue in the first nine months of fiscal 2010 was $19.0 million, a 10.4% increase over the first nine months of fiscal 2009. · Promina revenue remains significant, but will continue to decline over time. Promina revenue for the first nine months of fiscal 2010 was $13.3 million, a 27% decline compared to the first nine months of fiscal 2009. Promina products, which are based on time division multiplexing (TDM), continue to perform well for certain applications and we have a large installed base, particularly in the government. As a result, we expect to continue to see orders for Promina products for the next few years, but at a declining rate. · We expect our mix of product sales and our sector mix to fluctuate quarter to quarter. Our customers continue to move to IP-based communications at varying speeds, and spending by government customers fluctuates for the reasons noted above. The following table shows product revenue from our Promina product and IPbased platforms as well as total revenue from our government customers: (in thousands, except percentages)Three Months EndedNine Months EndedDecember
25, 2009December
26, 2008December
25, 2009December
26, 2008Revenue from government customers$12,016$15,280$43,136$38,793% of total revenue73.6%80.5%77.6%73.1%Promina product revenue$3,861$7,100$13,292$18,260% of product revenue30.8%46.4%31.0%43.5%VoIP-based product revenue$5,240$5,097$18,954$17,167% of product revenue41.8%33.3%44.2%40.9%  · We continue to manage expenses tightly. Expense for sales and marketing, research and development, and general and administrative each declined in the third quarter and first nine months of fiscal 2010 compared to the prior-year periods, except that general and administrative expense was higher in the third quarter of fiscal 2010 due to employee separation costs. On a temporary basis, most of our domestic employees have taken a 7.5% salary reduction, with executives taking reductions of 10% to 15%. The salary reductions were offset by grants of restricted stock. Revenue (in thousands, except percentages)Three Months EndedNine Months EndedDecember
25, 2009December
26, 2008ChangeDecember
25, 2009December
26, 2008ChangeProduct$12,550$15,304(18.0)%$42,835$42,0012.0%Service and other3,7733,6682.912,75911,06015.4Total revenue$16,323$18,972(14.0)%$55,594$53,0614.8%  Total revenue was lower in the third quarter of fiscal 2010 primarily due primarily to lower sales to Federal Government customers, offset by a slight increase in revenue from commercial customers. Total revenue was higher in the first nine months of fiscal 2010 primarily due to increased product revenue from government customers, and from the recognition of $1.5 million of revenue for funded research and development, which had been previously deferred and was recognized in the second quarter upon achievement of certain milestones. Product revenue was down in the third quarter of fiscal 2010 over the comparable prior-year period principally due to lower revenue from Promina sales to government customers. Product revenue was higher in the first nine months of fiscal 2010 over the comparable prior-year period as a result of higher NX1000 and VX product sales in the first and second quarters, partially offset by declines in Promina and Quintum Tenor revenue. Sales associated with the basic VoIP applications that were a large part of the traditional Quintum business have declined as we shift our focus to more-advanced unified communications, SIP-trunking, and other applications supported by our VX Series products. Service and other revenue increased in the third quarter and first nine months of fiscal 2010. The increase in the third quarter was due to a slight increase in professional services. The increase in the first nine months was primarily a result of the recognition of the $1.3 million of previously deferred service and other revenue in the second quarter. 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 and contractual acceptance provisions. Gross Margin Three Months EndedNine Months EndedDecember
25, 2009December
26, 2008December
25, 2009December
26, 2008Product gross margin47.6%55.3%49.9%15.4%Service and other gross margin14.93.814.40.5Total gross margin40.0%45.3%41.8%12.3%  Total gross margin increased in the first nine months of fiscal 2010 compared to fiscal 2009 primarily as a result of: · An absence of impairment charges. We recorded one-time impairment charges of $9.7 million in the second quarter of fiscal 2009. · Lower fixed costs. In the third quarter and first nine months of fiscal 2010, our fixed manufacturing costs were $1.3 million and $3.8 million, respectively, compared to $1.4 million and $4.8 million in the prior-year periods. These reductions in fixed costs resulted from various cost reduction programs. · Lower inventory reserve charges. In fiscal 2009, we recorded substantial inventory reserve charges. For the first nine months of fiscal 2010, inventory reserve charges were $1.7 million compared to $5.0 million for the first nine months of fiscal 2009. The largest portion of our inventory reserves, including those taken in fiscal 2009, were in response to reduced product sales due to delayed government programs involving our NX5010 product. We believed these delays would hurt demand for this product, as a new generation of the product was expected in fiscal 2010. We currently expect that the unreserved NX5010 inventory balances on hand and owned by our contract manufacturer, Plexus Corp., of $476,000, will be sold prior to the introduction of the new generation products, but we will continue to evaluate this inventory as well for possible impairment. · An absence of amortization charges on developed technology. In the first nine months of fiscal 2009, we took charges of $592,000 for amortization of developed technology acquired from Quintum, which was charged to product cost. We recorded an asset impairment charge for the full carrying value of developed technology in the second quarter of fiscal 2009. Service and other gross margin increased in the third quarter and first nine months of fiscal 2010. The increase in the third quarter was due to increased professional services and reduced fixed costs, including lower headcount. The increase in the first nine months was primarily a result of the recognition of the $1.3 million of previously deferred service and other revenue, as well as generally higher revenues and lower costs. Cost savings were realized through headcount reductions and related expense savings. Operating Expenses (in thousands, except percentages)Three Months EndedNine Months EndedDecember
25, 2009December
26, 2008ChangeDecember
25, 2009December
26, 2008ChangeSales and marketing$4,668$5,159(9.5)%$14,688$16,599(11.5)%Research and development5,0535,123(1.4)14,46117,251(16.2)General and administrative3,5832,87224.89,1689,885(7.3)Restructure and other (recoveries) costs(7)1,420(100.5)171,814(99.1)Impairment of goodwill and long-lived assets34,197(100.0)Total operating expenses$13,297$14,574(8.8)%$38,334$79,746(51.9)%  Total operating expenses in fiscal 2010 decreased primarily because of the absence of impairment charges which affected operating expenses in fiscal 2009. Cost control measures implemented in fiscal 2009 also contributed to the decrease in operating expenses. The cost control measures include reduced facilities and information technology costs, which are allocated among the various expense line items. Sales and marketing expense decreased in fiscal 2010. Changes in sales and marketing expenses were as follows: · Cost-reduction initiatives were responsible for the following expense reductions: o Payroll-related and consultancy costs were lower by $277,000 and $673,000 for the third quarter and first nine months of fiscal 2010 due principally to the effects of lower headcount and temporary salary reductions. o Travel and entertainment costs were lower by $65,000 and $438,000 for the third quarter and first nine months of fiscal 2010, respectively. o Marketing communication costs were lower by $244,000 and $736,000 for the third quarter and first nine months of fiscal 2010, respectively. The higher level of cost in fiscal 2009 was principally due to a new customer acquisition program which ran through the first three quarters of fiscal 2009 and advertising costs relating to programs that have been discontinued in fiscal 2010. · There was no amortization of purchased intangibles in fiscal 2010. Intangibles amortization expense was $664,000 in the first nine months of fiscal 2009. · Offsetting these savings, sales commissions were higher for the first nine months of fiscal 2010 by $473,000, reflecting higher bookings. Non-cash stock compensation was higher by $80,000 and $347,000, for the third quarter and first nine months of fiscal 2010 due to the effect of restricted stock grants awarded in connection with salary reductions, and to charges of $224,000 for award modifications incurred in the first quarter of fiscal 2010 in connection with the retirement of our former Federal sales executive. The reduction in payroll-related and consultancy costs for the first nine months of fiscal 2010 was net of employee separation costs of $490,000 also incurred in connection with the retirement of our former Federal sales executive. · Other miscellaneous sales and marketing costs were higher by $16,000 and lower by $219,000 in the third quarter and first nine months, respectively, of fiscal 2010. The change in the three-month period was largely due to changes in allocated expenses as reductions in company-wide allocated costs were offset by the effect of revised allocations to reflect actual utilization of facilities and services. The change in the nine-month period was largely due to reduced consignment inventory reserve charges in fiscal 2010. Research and development expense decreased in fiscal 2010 due primarily to the effect of cost reduction programs as we consolidated our research and development plans into a single company-wide strategy. Changes in research and development expenses were as follows: · Cost reduction initiatives were responsible for the following expense reductions: o Payroll-related and consultancy costs were lower by $233,000 and $2.6 million for the third quarter and first nine months of fiscal 2010, respectively, due to lower headcount and temporary salary reductions. o Depreciation and other operating expenses were lower by $122,000 and $438,000 for the third quarter and first nine months of fiscal 2010, respectively. o Allocations of shared expenses, including facilities and information technology costs, were lower by $16,000 and $182,000 for the third quarter and first nine months of fiscal 2010, respectively, due to a reduction in company-wide allocated costs and also to revised allocation percentages to reflect actual utilization of facilities and services. · These expense reductions were partially offset by non-cash stock option compensation, which was higher by $157,000 and $383,000 for the third quarter and first nine months of fiscal 2010, respectively, due to the effect of restricted stock grants, awarded mostly in connection with offsets to salary reductions. Also, engineering related costs were higher by $144,000 and $76,000 for the third quarter and first nine months of fiscal 2010, respectively, due primarily to new product development initiatives. General and administrative expense were higher in the third quarter of fiscal 2010 but lower for the first nine months of fiscal 2010, compared to the prior year periods. The increased expense in the third quarter of fiscal 2010 was principally due to employee separation costs incurred in connection with the departure of our former Chief Financial Officer. The decreased expense for the first nine months of fiscal 2010 was due primarily to the effect of company-wide cost reduction programs. Changes in general and administrative expenses were as follows: · Cost reduction initiatives were responsible for the following expense reductions: o Payroll related and consultancy costs were lower by $311,000 and $968,000 for the third quarter and first nine months of fiscal 2010, respectively, due to lower headcount and temporary salary reductions and reduced usage of consultants. o Other operating expenses decreased by $67,000 and $267,000 for the third quarter and first nine months of fiscal 2010, respectively. o Allocations of shared expenses, including facilities and information technology costs, were lower by $34,000 and $188,000 for the third quarter and first nine months of fiscal 2010, respectively, due to a reduction in company-wide allocated costs and also to revised allocation percentages to reflect actual utilization of facilities and services. · There was no amortization of purchased intangibles in fiscal 2010, versus intangibles amortization expense of $88,000 in the first nine months of fiscal 2009. · Outside services were higher in the third quarter and first nine months of fiscal 2010 by $245,000 and $119,000, respectively, principally due to patent lawsuit defense costs. · In the third quarter of fiscal 2010 we incurred employee separation costs of $878,000 in connection with the departure of our former Chief Financial Officer. Restructuring charges and recoveries in fiscal 2010 principally were as a result of employee separation costs relating to corporate restructuring initiatives. Restructuring charges in fiscal 2009 also related to corporate restructuring initiatives, and primarily resulted from a change in our estimate of the cost to vacate certain facilities as well as costs relating to headcount reductions. Non-Operating Items (in thousands, except percentages)Three Months EndedNine Months EndedDecember
 25, 2009December
 26, 2008ChangeDecember
 25, 2009December
 26, 2008ChangeInterest income$330$868(62.0)%$1,218$3,073(60.4)%Interest expense$(555)$(833)(33.4)%$(1,717)$(3,285)(47.7)%Gain on extinguishment of debt$$18,776(100.0)%$555$28,927(98.1)%Other income, net$186$322(42.2)%$414$29938.5%  Interest income was lower in fiscal 2010 due to lower average cash balances and, to a lesser extent, to lower average interest earned on investments. Average cash balances were lower primarily due to the effect of operating losses in the full fiscal year 2009 and in fiscal 2010, as well as the use of cash to repurchase and retire a total of $75.5 million of the outstanding 33⁄4% convertible senior notes and 71⁄4% redeemable convertible subordinated debentures. Interest expense was lower in fiscal 2010 reflecting the retirement of a portion of our outstanding debt through repurchases in the full fiscal year 2009 and in fiscal 2010. In 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. In the first nine months of fiscal 2009, we repurchased a total of $72.0 million of the principal amount of our outstanding 33⁄4% convertible senior notes at a discount to the original issue price. We realized a net gain of $28.6 million, consisting of a $30.8 million gain resulting from the repurchase of debt at below principal, partially offset by a $2.2 million write-off of unamortized deferred financing costs related to the repurchased debt. The net gain on these transactions was recorded as non-operating income. Other income, net, consisted of: (in thousands)Three Months EndedNine Months EndedDecember
 25, 2009December
26, 2008December
 25, 2009December 26, 2008Gain (loss) on foreign exchange$22$29$(6)$(166)Realized gain on investments164293398475Other22(10)$186$322$414$299  Income Tax Provision Income tax provisions (benefits) were ($1,000) and $43,000, respectively, for the three and nine months ended December 25, 2009, and $61,000 and $15,000, respectively, for the three and nine months ended December 26, 2008. All 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 benefits recorded as a result of the credit amounted to $24,000 and $76,000, respectively, for the three and nine months ended December 25, 2009, and $23,000 and $114,000, respectively, for the three and nine months ended December 26, 2008. 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 balances, cash provided by operating activities, debt financings, and committed credit lines. Cash Balances:As of December 25, 2009, cash and cash equivalents and short-term investments were $85.1 million, as compared to $97.0 million as of March 27, 2009. These amounts at December 25, 2009 were invested 86.5% 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 $8.4 million in the first nine months of fiscal 2010 compared to $18.3 million in the first nine months of fiscal 2009. The decrease in net cash used in operating activities resulted principally from the difference in net loss, which was $29.5 million lower in fiscal 2010, and the difference in gain on extinguishment of debt, which was $28.4 million higher in fiscal 2009. These amounts were partially offset by the absence in 2010 of impairment of goodwill and long-lived assets, which was $43.9 million in 2009. Net cash used in operating activities was also affected by differences in the amount of changes in assets and liabilities, particularly accounts receivable. Collections on accounts receivable were lower in fiscal 2010 than in fiscal 2009 principally because revenues in the fourth quarter of fiscal 2009 were lower than in the fourth quarter of fiscal 2008. Days sales outstanding (DSO) was 48 days and 58 days at December 25, 2009 and December 26, 2008, respectively. The effect of reduced collections on accounts receivable was partially offset by the amount of changes in balances of prepaid assets and accounts payable which, collectively, were responsible for a $10.8 million reduction in net cash used in operating activities. Also affecting net cash used in operating activities, to a lesser extent, was reduced depreciation, amortization and accretion; and higher stock-based compensation expense. Cash Flows from Investing Activities:Net cash used by investing activities was $21,000 in the first nine months of fiscal 2010 compared to cash provided by investing activities of $30.1 million in the first nine months of fiscal 2009. 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 $1.3 million in fiscal 2010 and provided net cash of $32.1 million in fiscal 2009. In fiscal 2009, the Company used the net cash provided by purchases, sales and maturities of short-term investments to fund the repurchases of debt and common stock. Cash Flows from Financing Activities:Net cash used in financing activities in fiscal 2010 was $2.2 million compared to $43.0 million used by financing activities in fiscal 2009. In both fiscal 2010 and fiscal 2009, our principal financing activities were repurchases of debt and common stock. In fiscal 2010 we paid $1.9 million to repurchase a portion of our outstanding 33⁄4% convertible senior notes. We also paid $929,000 to repurchase common stock from employees to satisfy withholding-tax obligations arising from the vesting of restricted stock awards. In fiscal 2009 we paid $41.2 million to repurchase a portion of the 33⁄4% convertible senior notes, $640,000 to repurchase a portion of our outstanding 71⁄4% redeemable convertible subordinated debentures and $1.3 million to repurchase common stock on the open market, primarily under our 2008 stock repurchase plan. Cash provided by proceeds from exercises of stock options was $607,000 in fiscal 2010 and minimal in fiscal 2009. Future proceeds to us from the issuance of common stock under employee stock plans will be affected primarily by fluctuations in our stock price. Non-cash Investing Activities:The primary non-cash investing activity in fiscal 2010 was an unrealized loss on available-for-sale securities of $148,000. We also acquired assets under capital leases of $145,000 in the third quarter of fiscal 2010. In fiscal 2009 our most significant non-cash investing activity was a net unrealized loss on available-for-sale securities of $47,000. Stock Repurchase Plan:  In February 2008, the Board of Directors approved a stock repurchase plan for a period of up to twenty-four months. We first repurchased shares under the 2008 program in fiscal 2009. In the full fiscal year 2009, we repurchased a total of 258,000 shares under the 2008 program at an average price of $3.90 per share for a total price of $1.0 million. We have not repurchased shares under this program in fiscal 2010. Contractual Obligations and Commercial Commitments:Our contractual obligations consist of facilities leases with noncancellable terms in excess of one year, principal and interest on our 33⁄4% convertible senior notes and our 71⁄4% redeemable convertible subordinated debentures, a license and development agreement with a third party to develop new products, and $656,000 of long-term income taxes payable as of December 25, 2009 related to uncertain tax positions. Our contractual obligations and contingencies decreased $8.3 million from March 27, 2009 primarily due to ongoing operating lease payments and the repurchase and retirement, in May 2009, of a portion of the outstanding 33⁄4% convertible senior notes issued in December 2007. This decrease in other contractual obligations and contingencies was net of an increase of $286,000 in new capital lease and equipment loan obligations. The following table provides a summary of our long-term debt and related interest payment obligations at December 25, 2009: Contractual Obligations
(in thousands)Total20102011
to 20122013
to 2014After
2014Long-term debt$34,204$$$$34,204Interest on long-term debt$9,703$$4,225$4,225$1,253  There was no significant change to our other contractual obligations in the nine months ended December 25, 2009. 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 $656,000 at December 25, 2009. 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 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, unless there is future forecasted demand for such inventory, in which case we must pay a management fee for such inventory and if the forecasted demand does not materialize we must then take ownership and pay for such inventory. This activity may increase our owned inventories. At December 25, 2009, Plexus held inventory related to our products. Our deposit relating to this inventory was $5.1 million at December 25, 2009 and reserves relating to this deposit were $2.0 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. We have been incurring legal fees to defend patent lawsuits on behalf of our subsidiary, Quintum Technologies, LLC, which we acquired in December 2007. Under the acquisition agreement with Quintum, we are indemnified against liabilities related to these matters. The escrow provisions include a $1.0 million cash escrow, specifically for patent claims, and a general escrow, also available for patent claims, in the amount of $5.0 million, half of which is cash and half of which is in Company stock. We have made claims against each escrow for certain such liabilities and the $1.0 million cash escrow has been exhausted. For purposes of satisfying escrow claims, Company stock is to be valued at $11.83 per share, which was the price used to determine the number of shares paid in the acquisition of Quintum. To the extent a claim is satisfied in Company stock and the Companys stock price at such time is below $11.83 per share, we will record expense for the price difference. Accordingly, depending on the trading price of the Companys stock, we will record expense for a portion of the amount of legal fees incurred in the litigation, even if claims for such amounts are satisfied from the escrow. In the first nine months of fiscal 2010, we recorded charges of $546,000 relating to price differences relating to indemnified claims and the escrow provisions. At December 25, 2009, we have accrued $601,000 for price differences relating to unsettled indemnified claims and the escrow provisions. Amounts accrued relating to price differences are based upon our stock price at the time such accruals are recorded. Upon settlement of claims, we will adjust the amounts accrued to reflect our stock price at the settlement date. Therefore, if our stock price is lower at the settlement date than at the expense accrual date, we will record additional expense. If the stock price is higher at the settlement date than at the expense accrual date, we will reduce the amounts accrued accordingly. 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 nine months ended December 25, 2009 from the information reported under Part II, Item 7A of our Form 10-K for the fiscal year ended March 27, 2009: A 10% change in market interest rates would change the fair value of our investment portfolio by $52,000, as compared to a change of $123,000 as of March 27, 2009. A 10% change in the foreign currency rates affecting our foreign exchange contracts as of their December 25, 2009 levels would change the fair value of the contracts by $400,000, as compared to a change of $560,000 for the contracts as of March 27, 2009. The fair market value of our 33⁄4% convertible senior notes is sensitive to changes in interest rates and to the price of our common stock into which it can be converted as well as our financial stability. In May 2009, we repurchased and retired $2.5 million principal amount of these notes. The yield to maturity on the notes is fixed, therefore the interest expense on the debt does not fluctuate with interest rates. The fair value of the 33⁄4% convertible senior notes was $8.0 million as of December 25, 2009 as compared to $7.8 million as of March 27, 2009. The fair value of the 71⁄4% redeemable convertible subordinated debentures was $20.9 million as of December 25, 2009 as compared to $15.9 million as of March 27, 2009.  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 Vice President, Finance (Principal Financial and Accounting Officer), 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 Vice President, Finance (Principal Financial and Accounting Officer), has concluded that our disclosure controls and procedures are effective as of December 25, 2009. No changes in our internal control over financial reporting occurred during the quarter ended December 25, 2009 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 exists the possibility of a material adverse impact on our business, results of operations and financial position. ITEM 1A. RISK FACTORS  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. 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 December 25, 2009: Fiscal PeriodTotal Number of Shares Purchased (1)Average Price Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2)Approximate Dollar Value of Shares That May Yet Be Purchased Under the Publicly Announced Plans or ProgramsSeptember 26  October 23, 2009$18,991,000October 24  November 20, 2009$18,991,000November 21  December 25, 2009$18,991,000$18,991,000 (1) In addition to shares purchased under publicly announced plans or programs, 74,935 shares were acquired directly from employees as payment of tax withholding obligations upon vesting of restricted stock awards. (2) In February 2008, the Board of Directors approved and the Company publicly announced a plan providing for the repurchase of up to $20 million of the Companys common stock for a period of up to twenty-four months.  ITEM 3.  DEFAULTS UPON SENIOR SECURITIES Not applicable.  ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable.  ITEM 5.  OTHER INFORMATION Not applicable.  ITEM 6.  EXHIBITS  (a) Exhibits 31.1Rule 13a-14(a) Certification (CEO).31.2Rule 13a-14(a) Certification (Vice President, Finance - Principal Financial and Accounting Officer).32.1Section 1350 Certification (CEO).32.2Section 1350 Certification (Vice President, Finance - Principal Financial and 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:  February 2, 2010 NETWORK EQUIPMENT
TECHNOLOGIES, INC.    /s/ C. NICHOLAS KEATING, JR.C. Nicholas Keating, Jr.
President and Chief Executive Officer   /s/ DAVID WAGENSELLER David Wagenseller
Vice President, Finance
(Principal Financial and Accounting Officer)