ITEM 1.
BUSINESS
Overview
Network Equipment Technologies, Inc. (NET), founded in 1983, develops and sells high performance networking equipment optimized for real-time communications. For more than a quarter of a century, NET has delivered solutions for multi-service networks requiring high degrees of versatility, security and performance. Today, the company is focused on providing secure real-time communications for unified communications (UC), session-initiation protocol (SIP) trunking, enterprise mobility, and IP-based multi-service networking. In 2007, in order to enhance our lineup of voice over IP (VoIP) offerings, we acquired Quintum Technologies and its Tenor product line.
Our enterprise customer base includes large enterprises adopting UC and small- to mid-sized businesses (SMBs) implementing real-time communications. Our government customers include a variety of federal and international agencies and organizations, including civilian and defense agencies and resellers to such entities. In addition to our direct sales capabilities, we have developed relationships with integrators, resellers, and vendors of related technologies in order to help drive our enterprise business. Our global support and service organization, along with third-party service organizations, provides installation and other professional services, a variety of maintenance programs, technical assistance, and customer training.
Today, our solutions are focused on enabling our enterprise and government customers to cost-effectively migrate to next-generation IP networks utilizing real-time communications, including unified communications platforms, cloud-based voice, secure voice applications, and high-speed multiservice wide area networking (WAN) transport networks. Our newest product offering, the UX Series, was purpose-built for the unified communications and enterprise session border controller (E-SBC) markets to enable adoption of new communication technologies and services. Our voice solutions include the VX Series and the Tenor product lines of switching media gateways. Our legacy multi-service solutions include the Promina platform and the NX Series high speed multi-service network exchange platform.
The UX Series is an enhanced gateway with an embedded server that acts as a survivable branch appliance (SBA), which is a key component for remote-site survivability. The UX Series interoperates with our VX Series and Tenor products and was specifically designed to support upstream deployments with advanced features that give customers high levels of flexibility, scalability, quality of experience, and investment protection through interoperability. The VX Series and Tenor product lines provide enterprise customers with voice interoperability solutions that enable existing private branch exchange (PBX) and IP-PBX systems to work together with new UC platforms and IP-based service provider networks offering SIP trunking services. The VX Series also provides IP-based solutions to government agencies requiring high bandwidth efficiency and call performance for secure voice communications. The Tenor product line also provides traditional VoIP switching gateway solutions for SMBs and smaller branch offices within large enterprises.
Our legacy multi-service solutions include the Promina, NX1000 and NX5010 platforms. The Promina product line has been serving government agencies and large enterprises for many years, providing industry-leading network reliability and security. The NX Series products are high-performance networking platforms that provide high-grade data transfer and enable secure grid computing. Our NX1000 platform provides an extensive, compact, wide-area network (WAN) switching solution that enables applications to integrate and aggregate into IP-based networks. The NX5010 platform enables high-speed, secure interconnection and extension of geographically distributed grid computing clusters and storage area networks (SANs).
Our consolidated financial information for the last three fiscal years is set forth under Item 8 - Financial Statements and Supplementary Data. We use consolidated financial information in determining how to allocate resources and assess performance. For this reason, we have determined that we are engaged in a single reportable segment.
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Industry Background
Telecommunications networks have evolved rapidly over the past few decades. Initially, there was a shift away from public networks and application-specific networks to integrated private networks. Circuit-switching technologies, such as time-division multiplexing (TDM), were used to achieve cost savings while maintaining high reliability. Later, higher bandwidths were achieved using switched digital services such as Integrated Services Digital Network (ISDN) and frame relay. Today, the Internet protocol, which uses packet switching for broadband networking, is used for an increasing portion of telecommunications traffic.
There is still currently a small market for circuit-switched products, particularly for networks requiring the most secure and reliably deterministic communications. Due to inherent bandwidth limitations, however, use of circuit-switched networking has been declining for a number of years, while IP-based networking has grown dramatically.
With the advent of IP-based technologies, traditionally separate voice and data environments have converged. VoIP offers both cost savings and added functionality, and its use by consumers, enterprises, telecommunication service providers and others has grown significantly in recent years. Recent innovations also allow IP-based connections to include services not available on traditional voice-only networks, such as instant messaging (IM) and video conferencing. Encryption and other security enhancements can now mitigate the risks of using open packet-routed networks.
The adoption of new technologies has led to a proliferation of communications equipment and devices such as PBXs, mobile phones, and desktop-PC clients, along with a multitude of communications tools such as e-mail, voicemail, calendaring, as well as IM and conferencing, which are increasingly combined as unified communications. To address this complexity, a number of large information technology vendors including Microsoft, HP and IBM have developed strategies and platforms aimed at integrating these various forms of communication. Any solution must be able to access the hardware of existing telephony networks as well as new wired and wireless IP telephony services and devices. For unified communications to work effectively, the communication connectivity must be device-, application-, and network-independent. In addition, businesses typically require capabilities for remote office support and survivability, security, high call-processing performance, and the ability to handle special routing and administration needs.
Enterprises looking to further cut their communications costs may opt to implement UC in a hosted environment, in which case they will typically want to deploy a network demarcation device like an enterprise session border controller (E-SBC). An E-SBC can secure their enterprise communications when deploying hosted UC, can interwork with existing infrastructure, and can provide survivability options in case the connectivity to the service provider goes down. An enterprise deploying an E-SBC can also run various value added business applications on the single device.
Business Strategy
Our strategy is to provide customers with intelligent, multi-service network and VoIP platforms for the secure session mediation of voice, video, and data traffic that are designed to:
● enable unified communications;
● support intelligent connectivity of new and legacy communications equipment;
● support a broad array of communication protocols and new communications technologies, including SIP trunking and session border control;
● extend the viability of legacy communications systems and facilitate network evolution;
● reduce the risks associated with introducing new network technologies into customers’ operations.
The following are key elements of our strategy:
Align with partner-driven UC strategies. We are focused on expanding our network of global partners with the scale and expertise to address UC market opportunities. Microsoft, HP, Dell and other large hardware and software vendors are pursuing strategies and products for the UC market. As a technology enabler of their strategies, we have worked and will continue to work closely with these companies. Microsoft has been a customer of ours for several years. This relationship has helped us to align our product development and resources to support Microsoft’s unified communications strategy and, as a result, we believe we are positioned to partner with other Microsoft solution providers. Through alliances with well-respected systems integrators and resellers, we are establishing channels for our products into the enterprise and government markets.
Leverage our incumbent market position. We were a pioneer of the concept of multi-service networking and have been delivering these mission-critical capabilities for more than 25 years. The installed base and revenue contribution from our earlier product lines are declining, but these product lines continue to generate a significant portion of our revenue. We intend to leverage our installed customer base for future sales of our new platforms.
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Design and develop industry leading communications equipment. We consider technological and product leadership to be critical to our future success. We have broad experience with mixed-service and multi-protocol networks, enabling us to develop solutions for a wide range of applications. We have extensively refined the features and technologies of our more mature products over their long product lifecycles. We strive to leverage this technological background to develop new products and additional functionality for existing products to meet our customers’ escalating requirements, specifically for VoIP conversion and secure voice applications. We believe that our newer products are helping accelerate the communications industry's rapid transition to software.
Leverage relationships with distribution partners and key technology providers. In addition to direct sales to large enterprise and government customers, we are expanding our relationships with resellers, distributors, and other vendors. We enter agreements with technology suppliers to supplement our internal development efforts and may enter agreements with original equipment manufacturers for penetration into specific markets. We also seek relationships with systems integrators, software solutions providers, and large incumbent vendors globally that can facilitate success in global enterprise networks, expansion of our sales channel, and participation in major government projects.
Provide value-added service and system integration capabilities. Since our inception, we have viewed customer service and support as a key element of our overall strategy and a critical component for our long-term relationship with customers. Customers around the world turn to us not only for the reliability and performance of our products but also for our comprehensive support services that optimize the value of those products.
Our Products
Voice and Mobility Products
Our voice and mobility platforms include our UX Series mediation platform, our VX Series switches, our Tenor gateways and our SmartSIP software.
UX Series - our new high performance mediation platform:
The UX Series of products are built on our next generation, high-performance mediation platform that was purpose built for unified communications, enterprise session border controller (E-SBC) for SIP Trunking and multi service business gateway markets. The UX2000 addresses needs of enterprise headquarters or large branch offices. With the introduction of our latest product in the series, the UX1000, we have expanded our offering to cater to the needs of smaller enterprise branch offices.
The UX2000 is a modular rack unit system that was purpose-built for unified communications, E-SBC, and multi-service business gateway applications. The UX2000 is equipped with up to six high performance DSPs and two telecom card slots with a choice of 2, 4, or 8 port DS1 cards, offering the industry’s best mediation processing for IP-to-TDM, IP-to-IP, or TDM-to-TDM solutions. An optional server-class application solutions module (ASM) with a high-performance Intel core i7 processor can also be added for third-party application support. The UX2000 core features a 24Gbps, non-blocking, IP-core backplane capable of routing more than 35 million packets per second.
The UX2000 is architected to meet the demands of any size branch office and can scale to up to 1,000 users. Its design flexibility provides unique capabilities for an invest-as-you-grow model and allows for future growth both in terms of the number of users supported as well as in the number of applications deployed. The modular architecture is designed to support scaling up of digital signal processing capacity and Time Division Multiplexing (TDM) interconnections providing deployment flexibility. Enterprises can now deploy a single device for all networking and communication needs and save both capital and operational expenses. In contrast to media gateways, which can have severely degraded call capacities during high complexity media processing operations, the UX2000 can support up to 600 simultaneous transcoded and encrypted calls. By supporting a variety of protocols, advanced security, and codec transcoding, the UX2000 enables a distributed enterprise to cost-effectively implement unified communications across the enterprise.
The UX2000 offers powerful quality of experience features, industry leading voice quality, intelligent call routing, call forking, and comprehensive PBX interoperability. As with the VX Series, directory-based call routing is built directly into the UX Series platform. The UX2000 is fully managed using a Web-based management interface with remote management capability, providing a solution for remote sites/branch offices that have minimal IT support. The UX2000 is qualified for Microsoft Lync Server 2010 as an Enhanced gateway and acts as a Survivable Branch Appliance - a key component of the Microsoft Lync Server topology. The UX2000 connects Microsoft Lync Server 2010 to SIP Trunking service providers as well as to legacy PBX and IP-PBX equipment. In the event WAN network failure occurs, the UX2000 provides survivability through the PSTN. The Survivable Branch Appliance application on the UX2000 ensures that local unified communication services are available so that the branch office continues to operate even when the IP network to the headquarters/datacenter is unavailable.
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When deployed as an E-SBC, the UX2000 provides defense against malicious attacks in addition to providing transcoding, service assurance, data routing, WAN access, and survivability.
The UX1000 is built with the same modular design as the UX2000 and runs the same software as the UX2000. The UX1000 addresses the needs of small to medium enterprise branch offices. The UX1000 has an application solutions module (ASM) that is available in a choice of processor speeds. With its qualification as a Microsoft Lync SBAv2, the UX1000 is capable of virtualizing business applications to run side-by-side with the Lync SBA thus providing a cost-effective solution for even smaller branch offices. The UX1000 supports connecting analog devices like fax machines directly to UX1000, a feature that is often needed by smaller branch offices, and also supports interfaces like BRI (Basic Rate Interface) and FXO (Foreign eXchange Office Interface) which are common infrastructure requirements for enterprise branch office communication.
The UX1000 is also ideal as customer premise equipment for enterprises opting for a hosted UC solution. Its E-SBC function protects enterprise borders from security threats, its multi-service business gateway functions help reduce server count and consolidate network services, its flexible architecture allows interoperability with existing devices in enterprise networks and it has cost effective solutions to help enterprises deploy value added business applications without having to increase their server count.
In fiscal 2012, our UX Series products accounted for 18.7% of product revenue. In fiscal 2011, when UX series products were first offered for sale, these products accounted for less than 10% of product revenue.
The VX Series - our voice exchange platform:
The VX Series enables high-performance, secure VoIP communications. The VX Series is a fully-integrated multi-service voice switch, which can be deployed to integrate unified communications, SIP Trunking services, VoIP and VoIP-based systems into legacy voice network infrastructures. With its remote survivability features, the VX Series provides continuous, local call service and intelligent trunk routing in the event of network connectivity failures. It can also be integrated into existing mission critical networks as well as deployed as the primary solution in greenfield applications.
The VX Series product line consists of the VX1800, VX1200, VX900, VX900T, and the VX400. The VX platform supports from 1 to 32 T1 or E1 ports, and 6 Ethernet ports (2 Gig-Ethernet ports on VX1800), making it a compelling solution for enterprises, government entities and service providers looking to deploy IP-based voice networks. The VX Series combines the functionality of a Session Border Controller (SBC), media gateway, call control component, SS7/C7 signaling point, and H.323/SIP inter-working device in a single compact chassis. The VX Series supports a wide range of voice and call routing features. All of these are backed by key components that ensure the platform and the calls moving across it are secure. Conformance to the latest VoIP signaling and call control standards, such as SIP and H.323, guarantees interoperability within multivendor VoIP deployments. The VX Series provides scalable, high-performance IPSEC, SRTP and TLS encryption for VoIP communications.
To address the needs of the U.S. federal government, the VX Series provides a VoIP-based secure voice solution with high bandwidth efficiency and call performance. A high bandwidth utilization rate is particularly important in expensive, limited bandwidth situations such as satellite links. The VX Series also enables the use of secure calls on IP networks and end-to-end tactical-to-fixed site connectivity. Key features that enable high-quality secure voice calls include data compression, forward error correction, echo cancellation and jitter correction - all critical factors when operating in tactical, high-latency or unpredictable network environments. For tactical deployment, the VX Series is available in form factors small enough to fit into a backpack.
The VX Series (VX900, VX1200 and VX1800) is a JITC-certified Deployed Network Element (D-NE) and provides advanced MLPP, SCIP relay, and security features that are in line with the new AS-SIP UCR definition. Additionally, the VX Series offers a robust implementation of V.150 Universal Modem Relay that communicates between newly deployed secure IP phones and secure analog communications devices. The VX Series has been proven by use in DoD, NATO, and first responder deployments. The VX Series product line has been selected by the federal government to enable next-generation voice features and to continue to capitalize on existing voice assets while assuring the strict security and reliability standards required in DoD voice systems.
The VX Series switches have been qualified under the Microsoft Unified Communications Open Interoperability Program for Microsoft Exchange Unified Messaging, Microsoft Office Communications Server 2007, and Microsoft Office Communications Server 2007 Release 2, and Microsoft Lync Server 2010. The VX Series is also interoperable with Broadsoft Broadworks R16.SP1, which enables service providers to offer scalable SBC and media gateway solutions for enterprises seeking carrier hosted VoIP cloud services.
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The VXe software release offers enhanced value to enterprise voice customers by reducing the network infrastructure footprint and lowering the operational and capital costs for UC deployments. This solution is suited to large enterprises with multi-site locations such as banks, retail stores, and professional services firms that typically have multi-site requirements.
In fiscal 2012, 2011, and 2010, our VX Series and predecessor products accounted for 23.2%, 35.3% and 22.3% of product revenue, respectively.
Tenor product line - our multipath VoIP gateways:
The Tenor product line provides basic gateway support for Microsoft's unified communications (UC) platforms. The Tenor gateways have been qualified under the Microsoft Unified Communications Open Interoperability Program for Microsoft Exchange Unified Messaging, Microsoft Office Communications Server 2007 and Microsoft Office Communications Server 2007 Release 2. In addition, for Microsoft Lync deployments, the Tenor AF and AX Series products are used as Lync analog station gateways to provide Lync connectivity to analog endpoints. Tenor products also support applications of other major VoIP system and services vendors.
Tenor products support general business VoIP applications where there is no need for premium VX Series product features such as high speed signaling and media security, programmable call processing, integrated SBC functions, or Microsoft Active Directory-based integration. Like the VX Series, Tenor products support any-to-any multipath switching, provide branch office survivability, and are designed to simplify deploying VoIP applications into existing legacy voice networks. The Tenor product line also has a broad set of interfaces and configurations that allow them to be integrated into nearly any type of existing voice network, supporting as few as two analog ports and as many as 32 T1/E1 trunks or 960 VoIP calls.
The Tenor AF and AX Series VoIP gateways offer enterprises using analog ports an easy, cost-effective way to capitalize on the power of VoIP. These highly adaptable solutions work with traditional PBXs, legacy analog equipment, IP PBXs and IP phones, and SIP-based communications environments. For enterprises using ISDN lines, the Tenor BX integrates VoIP gateway functionality with intelligent call routing, multipath architecture, and QoS support. Enterprises can benefit from a variety of valuable applications such as PBX extension, remote office connectivity, long distance consolidation and call centers. With the Tenor DX VoIP gateways, enterprises and service providers can also deploy numerous VoIP applications such as SIP trunking, wholesale VoIP termination, calling cards, tandem switching and least cost routing.
In fiscal 2012, 2011, and 2010, Tenor products accounted for 24.4%, 18.6% and 16.6% of product revenue, respectively.
SmartSIP software - SIP for Lync and OCS:
Our SmartSIP application supports the new direction of collaboration in the workplace where real-time, integrated communications are driving increased productivity throughout the enterprise. SmartSIP allows wireless, DECT, and standard SIP phones to be provisioned and used as extensions in a Microsoft Lync Server 2010 deployment. The SmartSIP application is built using Microsoft Unified Communications Managed API (UCMA) to address the interoperability of Wireless, DECT and legacy SIP endpoints with Microsoft unified communications. SmartSIP reduces operating expenses by automatically provisioning the endpoints.
Multi-service Networking Products
Our multi-service networking platforms include Promina and the NX Series network exchange platforms.
Promina - our established multi-service access platform:
Our Promina family of multi-service access products integrates voice, data, image and video traffic across a single network infrastructure. The Promina platform, tailored to circuit-switched networks, provides mission-critical support for a wide variety of communications applications and traffic types, including ATM, frame relay, IP, and ISDN signaling. Promina products offer a broad range of user-side interfaces, enabling standards-based connection of communications equipment, whether located at a service provider’s switching facility or at an enterprise or government customer’s premises.
The Promina platform features advanced network management services, which provide a high degree of visibility into network operations. For fault tolerance and high network reliability, our Promina products can be configured with redundant power, common logic, and trunk interfaces. These products incorporate distributed network intelligence that allows the network to quickly and automatically reroute traffic in the event of failure of a component.
The Promina product family includes a range of systems for various node sizes, with various processor, application, and interface modules. Our Promina networks are monitored and controlled by netMS, an integrated network management solution. We also offer an IP trunk interface for Promina, enabling direct IP connections to the Promina platform.
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In fiscal 2012, 2011, and 2010, our Promina products, including the Promina Broadband Shelf, accounted for 24.9%, 33.8% and 38.6% of product revenue, respectively.
The NX1000 Series - our IP-enabled multi-service platform:
The NX1000, an extension of our Promina product line, provides a flexible, cost-effective IP aggregation solution that facilitates migration of legacy traffic to IP. It is fully interoperable with the existing Promina product line, delivering an all-new architecture and built-in capability to converge legacy applications onto an IP-based network while also providing four times the bandwidth of similarly sized Promina models. The NX1000 adds multi-service aggregation capabilities to the NX Series’ product line-up and is housed in a field-deployable, compact and lightweight chassis. It fits well into tactical and first-responder applications as well as supporting applications for high speed serial or legacy migration to IP, IP-based satellite transport, and tactical to fixed-site connectivity. The NX1000 also offers higher speed data interfaces, diskless data storage, and an optional rubidium atomic clock module to provide a high level of accuracy and synchronization for bit synchronous applications over IP.
In fiscal 2012, 2011 and 2010, NX Series product sales accounted for 7.9%, 8.6% and 21.9% of product revenue, respectively.
Customers and Markets
NET provides sophisticated network communications solutions to enterprises and government organizations worldwide. We pioneered multi-service networking and have been delivering this capability for more than 25 years. We are currently focused on the markets for UC, E-SBCs, and multi-service business gateway applications. Our customers are information and communication-intensive organizations, who may be local, national, or global in their operations. Our government customers include a variety of federal and international agencies and organizations, including civilian and defense agencies and resellers to such entities. Our enterprise customer base includes large enterprises adopting unified communications and small- to mid-sized businesses implementing VOIP technologies. Through our sales channel, we target enterprise customers in a variety of sectors such as financial services, manufacturing, transportation, and retail.
Sales to the government sector represented 50.2%, 71.1% and 78.6% of NET’s total revenue in fiscal 2012, 2011, and 2010, respectively. We do business with the government sector both as a direct contractor and as a subcontractor. A substantial portion of the revenue generated from our government customers is based on our contract with the General Services Administration (GSA), as well as through direct contracts such as with the Department of Defense and NATO. A new U.S. General Services Administration Schedule contract was issued to our NET Federal subsidiary in July 2010, providing an ongoing contracting vehicle for sales to the U.S. government. Some of these contracts may also be used by other government agencies.
In fiscal 2012 and fiscal 2011, no single customer accounted for more than 10% of the Company’s total revenue. In fiscal 2010, General Dynamics Corporation accounted for 22.7% of the Company’s revenue. Excluding aggregate orders from a variety of government agencies, no other single customer accounted for more than 10% of the Company’s revenue in fiscal 2012, 2011, or 2010.
Our commercial revenue from international customers accounted for 33.6%, 17.8% and 13.8% of total revenue for fiscal years 2012, 2011, and 2010, respectively. Going forward, we believe our revenue growth in the enterprise markets will largely be driven by the acceptance of UC and other enterprise secure voice applications. As an incumbent supplier into Microsoft’s internal voice network, we are working closely with Microsoft and its key partners as they introduce new enterprise-focused unified communications and unified messaging products, of which our UX Series is a key enabler.
Competition
The market for telecommunications equipment is highly competitive and dynamic, has been characterized by rapid changes to and the convergence of technologies, and has seen a worldwide migration from existing circuit technology to packet-based IP technologies. We compete directly, both internationally and domestically, with many different companies, some of which are large established suppliers of end-to-end solutions such as Alcatel-Lucent, Avaya, Cisco Systems, Juniper Networks and Siemens. In addition to these large suppliers, a number of other companies are targeting the same markets as we do. Particularly, Audiocodes Limited and Dialogic Corporation provide competitive solutions in the UC market, and Acme Packet provides competitive solutions in the SBC market. We believe our long operating history gives us some of the advantages of larger businesses, while our small size and targeted focus give us some of the advantages of smaller companies. Our larger competitors, however, have greater overall financial, marketing and technical resources than we do and offer a wider range of networking products than we offer and can often provide customers a complete network solution. They often can compete favorably on price because their sales volume and broad product lines can allow them to make discounted sales while maintaining acceptable overall profit margins. Conversely, our smaller competitors may have more ability than we do to focus their resources on a particular product development unencumbered by the requirements to support an existing product line, allowing greater flexibility in their market strategies.
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Sales
We sell our products and services through both direct and indirect sales channels worldwide, including large global systems integrators and government defense contractors. We support the sales force effort with systems engineers who provide customers with pre-sale technical assistance which allows us to gain more in-depth knowledge of customers’ network requirements. Our business is generally not seasonal, though we have been affected by delays in adoption of government entity budgets and spending patterns of the federal government at its September fiscal year end.
Our international sales, other than those made to foreign ministries of defense, are made through indirect channels that are augmented by the efforts of a local sales force. In addition to the marketing and sale of products, international resellers provide system installation and technical support. International resellers have non-exclusive agreements to resell NET products within particular geographic areas. Resale agreements do not contain a sales commitment or required sales quota.
Backlog
We manufacture our products based upon our forecast of customer demand, and we often build products in advance of receiving firm orders from our customers. Backlog is generated upon receipt of a valid customer purchase order. Backlog was $534,000 and $1.1 million at March 30, 2012, and March 25, 2011, respectively. We believe all of our backlog orders are firm and that backlog at the end of any given fiscal year can reasonably be expected to be filled in the following fiscal year period. Orders for NET’s products are generally placed by customers on an as-needed basis, and we typically have been able to ship these products within 30 to 90 days after the customer submits a firm purchase order. As a U.S.-based company, we are required to give priority to federal government rated “defense-expedite” orders, which may cause the backlog of other customers’ orders to become delinquent. Because of the possibility of customer changes in delivery schedules or cancellation of orders, NET’s backlog as of any particular date may not be indicative of sales in any future period.
Customer Service
The markets, customers and complex challenges of the networking industry described above require support, service and other assistance in the development, operation and expansion of a customer network. We provide a wide range of global service and support options to customers and resellers of our products. Service offerings include product installation and other professional services, a choice of different hardware and software maintenance programs designed to meet the varying needs of our customers, parts repair, remote and on-site technical assistance, and customer training. In addition, NET provides web-based services to assist the self-directed efforts of more technically capable customers and partners.
Our Technical Assistance Center (TAC), which is staffed by engineers trained in networking products, is set up to assist customers remotely over the telephone. TAC engineers have the ability to replicate customer problems and test proposed solutions prior to implementation. Maintenance support from TAC, whether provided over the web or over the telephone, is fee-based under either an annual fee contract or on a time-and-materials basis. TAC costs are charged to cost of service and other revenue.
Customer training on our products is provided to both end-users and resellers worldwide. We provide training both at NET facilities and at customer and reseller sites. Our training services can be customized to meet the special requirements of our customers. Customers are charged per person per class for training. We also offer a portfolio of computer-based training sessions for our products, which are licensed on an individual or site basis.
Through a contractual arrangement with our company, CACI International Inc. had certain rights to provide maintenance and other services to our federal government customers, until the expiration of the arrangement on December 1, 2010. Under this arrangement, both companies sold services for NET products, other than the Tenor products, and each company was responsible for various aspects of service delivery. Revenue from maintenance services was shared between both companies, regardless of which company sold the services. Since the expiration of this arrangement, the Company has performed these services itself and has retained all revenue associated with these services.
Our Tenor product line is in large part sold through distributors, who generally perform service and support to the end customers.
In fiscal 2012, 2011, and 2010, service and support revenue accounted for 30.0%, 23.7% and 22.0%, respectively, of NET’s revenue.
Manufacturing
We outsource our product manufacturing. For the Promina, NX Series and VX Series, we outsource our manufacturing, including assembly and structural test, to our primary contract manufacturer, Plexus Corp. (Plexus). For the new UX Series, we outsource our manufacturing to CTS Corporation (CTS) and Plexus. CTS is located in the U.S. and Plexus is located in the U.S. and in Malaysia. For the Tenor product line, manufacturing is performed by contract manufacturers in Asia and final assembly is performed at our own facilities in Hong Kong. Each of our contract manufacturers is the sole vendor with whom we have contracted for the assemblies and finished goods they manufacture for us.
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Under our agreement with Plexus, 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 pay a management fee for Plexus to retain such inventory. If there is no forecasted demand for all or any portion of such inventory in the forward-looking one year time period, then we must instead take ownership of, and pay for, that portion of the aged inventory without any demand. This activity may increase our owned inventories. The term of our agreement with Plexus currently runs to December 31, 2012, with automatic renewal for additional one-year terms unless either party gives notice of intent not to renew, and subject to either party’s right to terminate upon six months notice.
At March 30, 2012, our deposit on inventory held by Plexus was $2.3 million, of which $1.3 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 consolidated balance sheets.
The Company regularly evaluates its inventory for lower of cost or market valuation, including inventory held by Plexus and the amount on deposit with Plexus as well as inventory classified as non-current assets. As a result of these evaluations, we recorded charges of $2.1 million, $550,000 and $1.9 million to cost of revenue in fiscal 2012, 2011 and 2010, respectively.
Several key components of our products are available only from a single source, including certain integrated circuits and power supplies. Depending upon the component, there may or may not be alternative sources or substitutes. Some of these components are purchased through purchase orders without an underlying long-term supply contract. Any delay or difficulty in obtaining needed components could seriously impact our ability to ship products.
We attempt to maintain sufficient inventory to ship products quickly, normally within 30 to 90 days after receipt of an order. Scheduling of production and inventory supply is based on internal sales forecasts. Generally, our customer contracts allow the customers to reschedule delivery dates or cancel orders within certain time frames before shipment without penalty and outside those time frames with a penalty. Because of these and other factors, there are risks that excess or inadequate inventory levels could occur.
We are focused on continually enhancing the quality of products and services delivered to customers worldwide. This includes improving the quality of supplied components, subassemblies and internal processes. As part of this continuing process, NET is ISO 9001:2008 registered.
Research and Development
We believe that our long-term success depends on our ability to maintain product and technology leadership. The networking equipment industry is characterized by rapid technological change, evolving industry standards, frequent new product introductions, enhancements to products currently in the market and constantly changing customer requirements. To compete effectively, NET must be able to bring new products to market in a timely and cost-effective manner and provide existing customers an attractive migration path to our newer products. Along with making continued investments in our internal research and development, we also enter into development agreements with other technology suppliers and may make strategic acquisitions to obtain needed technology and resources.
We continually monitor relevant markets and our customers’ businesses and technology developments in order to develop products that proactively address customer needs. The majority of our research and development activity is focused on packet-based technologies, particularly session mediation.
While most product development activity is undertaken by NET employees, we enter into license and technology agreements to accelerate development of new products or expand the scope of development efforts, as well as outsource some of our product development activities.
In fiscal 2012, 2011, and 2010, NET’s research and development expenditures were $19.0 million, $19.2 million and $19.2 million, respectively.
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Working Capital
We fund our business principally through the utilization of proceeds from long-term borrowings. Additional information about our liquidity practices is included in Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Liquidity and Capital Resources” and is incorporated herein by reference.
Employees
As of March 30, 2012, we had 177 employees. None of our employees are represented by a labor union. We consider our employee relations to be good.
Geographic Information
See Note 13 to our consolidated financial statements.
Intellectual Property
We believe that our intellectual property is central to our success and ability to compete effectively. We devote considerable resources to invent and develop new technologies and then to protect these technologies from unauthorized use. We have a program to seek protection of our proprietary technology under various protection frameworks such as patent, trade secret, trademarks and copyright protection. We believe that ownership of patents, trade secrets, trademarks and copyrights is central to our ability to defend ourselves against intellectual property infringement allegations. We also seek to protect our inventions, trade secrets and other confidential information by non-disclosure policies. To aid in this effort our employees and contractors sign confidentiality and invention disclosure agreements, and persons outside NET to whom we disclose our confidential information either sign a non-disclosure agreement or are bound by a professional duty of confidentiality.
Where we believe patent protection for an invention is appropriate we will seek such protection in the United States and may also seek it in select foreign countries. Accordingly, including the U.S. patent issued during fiscal 2012, we have patented a number of our inventions in the United States, Europe, and Asia. We now hold 73 U.S. patents. Certain of our inventions under U.S. patent are also protected by patents in other countries. Depending on their original filing dates, which range from 1992 to 2007, our U.S. patents will expire between August 2012 and September 2027. We expect to continue filing patent applications as we develop new products and technologies. We have not historically pursued claims against other companies based on possible infringements of our patent portfolio, but we believe that our investment in intellectual property protection can offer defenses to claims against us and may provide an additional source of future revenue.
For each of our product lines, we license some of our technology from third parties. Some of these licenses contain limitations on distribution of the licensed technology, are limited in duration, require royalty payments, or provide for expiration upon certain events such as a change in control of the company.
Executive Officers
The executive officers of NET and their ages at May 25, 2012 are as follows:
David Wagenseller joined NET in 1986 and was named acting President and Chief Executive Officer on April 2, 2012. He previously served as the Company’s Chief Financial Officer, from April 2010 until being named to his current role. Prior to that, he held various positions in the Company’s finance department, including controllership, treasury and financial planning, and became Vice President of Finance in 2006. He served as the Company’s principal financial officer from November 2009 until April 2012. Mr. Wagenseller earned a bachelor’s degree in business administration from California State University, Dominquez Hills.
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Karen C. Carte joined NET in October 2010 as Vice President and Chief Accounting Officer, and was named acting Chief Financial Officer on April 2, 2012. For the seven years prior to joining the Company, she was an independent consultant providing high-level financial management and advisory services, with a focus on start-up ventures. Previously, she held executive positions in finance at Intella Interventional Systems and Alpine Microsystems. Prior to that, she was an accountant at Ernst & Young LLP. Ms. Carte holds a bachelor’s degree in business administration from the University of San Diego, and is a CPA.
James T. Fitzpatrick joined NET in April 2009. Prior to joining the Company, he was Vice President of Federal Sales for Ericsson Federal (formerly Marconi Federal). At Marconi Federal, he oversaw channel sales and partner programs and was in charge of business development. Mr. Fitzpatrick previously held senior management positions at NCR and AT&T, in the areas of sales, marketing, business development and large scale program management, along with legal, financial and contract management. Mr. Fitzpatrick earned a bachelor’s degree from Marquette University and a law degree from the University of Baltimore, and did additional graduate studies in information technology at Johns Hopkins University.
Kevin N. Isacks joined NET in 2000 through its acquisition of Convergence Equipment Company, a manufacturer of IP telephony platforms. Previously, he was an engineer for Wang Global, which was acquired by Getronics N.V. In addition to his experience in designing and architecting voice-over-IP (VoIP) products, he also has extensive expertise in unified communications. Mr. Isacks holds a B.Sc.Eng. from University of Natal, South Africa.
Francois P. Le joined NET in 2008. Prior to joining the Company, he was Vice President of Carriers and International Sales at Tropos Networks, the market leader in delivering metro-scale Wi-Fi mesh networks. Previously, Mr. Le was Vice President of Worldwide Sales for Aperto Networks, a supplier of WiMAX broadband wireless networks, where he started sales and extended the customer base into more than 50 countries and 150 operators. Prior to that, Mr. Le was Director of Product Marketing and Business Development for WAN access products at 3Com Corporation and Vice President of International Sales with Multipoint Networks. Earlier, he held Sales Director responsibilities at NET for Europe and later Asia-Pacific and Latin America. Mr. Le holds an MBA from the Stanford Graduate School of Business and an engineering diploma from the National Institute of Applied Sciences in Lyon, France.
Pete Patel joined NET in April 2008. Prior to joining the Company, Mr. Patel held a senior management position at Xirrus, Inc., a provider of next generation wireless LAN architecture. Previously, at Occam Networks, Advanced Fibre Communications, and Ericsson, Mr. Patel held various senior management positions including Vice President of Operations, Director of Operations, Director of Design Verification and Test Engineering, and Senior Test Engineering Manager. Mr. Patel holds an F.Y.B.Sc. in science from Gujarat University, India and a B.V.Sc. and A.H. from Gujarat Agricultural University, India.
Frank Slattery joined NET in February 2003. In addition to serving as General Counsel, he is the Corporate Secretary and oversees corporate governance matters. Mr. Slattery has been a business lawyer for technology companies since 1989, when he began his legal career at the firm of Wilson, Sonsini, Goodrich & Rosati. Prior to joining NET, he served in legal and senior management positions for a number of computer software and internet services companies, including SiteSmith, an internet infrastructure services provider, which was acquired by Metromedia Fiber Networks; USWeb, an internet services company; and ParcPlace Systems, a software tools developer. Mr. Slattery holds a bachelor’s degree in economics and a JD from the University of California, Davis.
Where You Can Find More Information
We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to such reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act, available free of charge on or through our Internet website located at www.net.com or the SEC’s website located at www.sec.gov. You may also read and copy any document we file at the SEC’s public reference room located at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Please call the SEC at (800) SEC-0330 for further information on the public reference room. Stockholders may also access and download free of charge our corporate governance documents, including our Corporate Governance Guidelines, Audit Committee, Compensation Committee and Nominating/Corporate Governance Committee Charters, and Code of Business Conduct, on or through this Internet website. In addition, any stockholder who wishes to obtain a printed copy of any of these documents should write to: Investor Relations, NET, 6900 Paseo Padre Parkway, Fremont, California 94555.
ITEM 1A.
ITEM 1A.
RISK FACTORS
We have incurred net losses in the past and may incur losses in the future.
With the exception of fiscal 2008, we have incurred net losses since fiscal 1998, including in fiscal 2012. Until recently, our circuit-switched product line, Promina, provided a substantial portion of our revenue. The market for that product line has declined significantly. In fiscal 2012, we recorded inventory reserve charges of $2.1 million, which contributed to the net loss. These charges in large part reflected end-of-life announcements issued in fiscal 2012 for some of the products in our Promina product line as well as changes in our expectations regarding the useful lives of certain inventory components for the Promina product line. In order for the Company to be profitable in future periods, we need our newer products to achieve commercial success. Any shortfall in revenue compared to our annual financial plan would likely require that we reduce spending, though the Company has already made significant expense reductions in recent fiscal years and many of our remaining costs are relatively fixed making it difficult to further reduce spending significantly.
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Our operating results and the market price of our common stock may continue to fluctuate significantly.
The market price of our common stock has fluctuated significantly in the past, will likely continue to fluctuate in the future and may decline. Fluctuations or a decline in our stock price may occur regardless of our performance. Among the factors that could affect our stock price, in addition to our performance, are:
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variations between our operating results and either the guidance we have furnished to the public or the published expectations of securities analysts;
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changes in financial estimates or investment recommendations by securities analysts following our business;
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announcements by us or our competitors of significant contracts, new products or services, acquisitions, or other significant transactions;
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the issuance by us of common stock or other securities in the future;
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the inclusion or exclusion of our stock in various indices or investment categories;
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changes in the stock prices of other telecommunications equipment companies, to the extent that some investors tend to buy or sell our stock based on segment trends;
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the trading volume of our common stock; and
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repurchases we make of our common stock or early retirement of debt.
Our future capital needs are uncertain and we may need to raise additional funds in the future.
We believe our existing cash, cash equivalents, and short term investments will be sufficient to fund our operations for at least the next twelve months. However, in light of our recent history of net losses, we may need to raise additional capital to fund our operations. In addition, we will be required to repay borrowings under our convertible senior notes and our redeemable convertible subordinated debentures currently totaling $34.2 million, in fiscal 2014 and 2015. Unless our future cash flow from operations is sufficient to repay such amounts in full, we will need to raise additional capital to repay such amounts or we will need to restructure or refinance these debt obligations, neither of which can be assured. Additional capital may not be available on terms that we consider acceptable or may not be available to us at all. If we raise capital by selling equity securities, our existing security holders may suffer dilution. If we raise capital by debt financing, we could be subject to covenants restricting our operations in ways that may prove detrimental to us. If additional capital is needed and we are unable to raise it on acceptable terms, we may have to delay, reduce the scope of, or eliminate some or all of our research and development programs or other operations, which may include delaying further development of our products; or reduce marketing, customer support or other resources devoted to our products or operations. Any of these developments could harm our business, results of operations, or financial condition.
We may not be able to maintain our listing on the Nasdaq Global Market.
Our common stock currently trades on the Nasdaq Global Market, which has continued listing requirements that we must satisfy in order to maintain our listing. The standards include, among others, a minimum bid price requirement of $1.00 per share. Our results of operations and our fluctuating stock price directly affects our ability to satisfy these listing standards. If we fail to do so, we may be subject to delisting. At certain times in the past, the market price of our common stock has been less than $1.00 per share. Recently our stock price has been trading at market prices around $1.00.
On March 22, 2012, we received a deficiency letter from NASDAQ notifying us that we were failing to meet The NASDAQ Global Market’s listing rules requirement for listed securities to maintain a minimum bid price of $1.00 per share, based upon the closing bid price of the our common stock for the 30 consecutive business days prior to the date of the letter. On April 10, 2012, we received notification from NASDAQ that we had regained compliance with the bid price requirement, as a result of our common stock remaining above $1.00 per share for the period from March 23, 2012 to April 9, 2012. The matter is now closed, however we remain subject to NASDAQ’s continued listing standards, including the bid price requirement.
A delisting from the NASDAQ Global Market could result in our common stock being listed on the NASDAQ Capital Market or on an over-the-counter market, each of which are generally considered to be a less efficient market than the NASDAQ Global Market. A delisting from the NASDAQ Global Market could have a number of other negative consequences, including greater difficulty in obtaining financing and a loss of confidence by customers, suppliers and employees. In addition, our convertible senior notes will become callable if our common stock ceases to be traded on a U.S. national securities exchange or established automated over-the-counter market. As of the date of issuance of these financial statements, we were in compliance with all applicable requirements for continued listing on the NASDAQ Global Market.
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A significant portion of our revenue is generated from government sales, which are subject to potential delays and cutbacks, require specific development efforts, and impose significant compliance obligations.
A significant portion of our total revenue from product sales has come from contracts with governmental agencies, most of which do not include long-term purchase commitments. A majority of these sales have involved our Promina product, for which sales have declined substantially in recent periods. While the government has purchased and is evaluating some of our new products for broader deployment, this new business may not develop quickly or be sufficient to offset future declines in sales of our Promina product. Spending by government customers fluctuates based on budget allocations and the timely passage of the annual federal budget. An impasse in federal government budget decisions could lead to substantial delays or reductions in federal spending. During 2011, the U.S. Government was unable to reach agreement on budget reduction measures required by the Budget Control Act of 2011 (the "Budget Act") passed by Congress. Unless Congress and the Administration take further action, the Budget Act will trigger automatic reductions in both defense and discretionary spending in January 2013. The resulting automatic across-the-board budget cuts in sequestration would likely cause a substantial reduction in revenues from our federal government customers.
The federal government has issued specific requirements for IP networking products to incorporate a technology referred to as “IPv6” and requires products destined for use in military applications be certified by the Joint Interoperability Test Command (JITC). If we are unable to complete development efforts necessary to support IPv6 within the timeframes required by the federal government or are unable to obtain JITC certifications as needed, our government sales, and hence our revenue and results of operations, may suffer.
A substantial portion of the revenue generated from our government customers is based on our contract with the GSA. This contract imposes significant compliance and reporting obligations on us. The contract also establishes a fixed price under which government customers may purchase our products and provides for automatic mandatory price reductions upon certain events. In addition, the GSA can impose financial penalties for non-compliance.
Our success depends on our ability to develop new products and product enhancements that will achieve market acceptance.
Our operating results will depend on the successful design, development, testing, introduction, marketing, and broad commercial distribution of our newer products. The success of these products is dependent on several factors, including proper product definition, competitive pricing, timely completion and introduction to the market, differentiation from competitors’ products, and broad market acceptance. Successful introduction of new products also requires the development of relevant expertise in our product support organization. The markets for our products are characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and evolving methods of building and operating networks. We may not successfully identify new product opportunities, develop and bring new products to market in a timely manner, or achieve market acceptance of our products. Our products and product enhancements are increasingly designed as elements of a solution involving products and technologies being developed by third parties, and the success of our products will therefore be affected by the availability and success of the third party products. At the same time, products and technologies developed by others may render our products or technologies obsolete or non-competitive, which in turn could adversely affect our ability to achieve profitability.
Gross margins could decline over future periods.
Gross margins may be adversely affected in the future due to increases in material and labor costs, increases in subcontractor charges, changes in the mix of products and services we sell, increased sales through resellers, increased warranty costs, or pressure on pricing and margins due to competition. As we introduce new products, our overall gross margins may decline, as new products typically have lower gross margins than established products, as a result of customary discounting for early customers and higher per-unit costs associated with low purchase volumes of components. A decline in our gross margins could have a material adverse effect on our business, results of operations, and financial condition.
Litigation may materially adversely affect our business.
Existing and future litigation may result in monetary damages, injunctions against future product sales and substantial unanticipated legal costs and may divert the efforts of management personnel, any and all of which could have a material adverse effect on our business, results of operations and financial condition.
Our operations in foreign countries are subject to political, economic and regulatory risks.
We conduct sales and customer support operations in countries outside of the United States and depend on non-U.S. operations of our subsidiaries and distribution partners. As a general rule, international sales tend to have risks that are difficult to foresee and plan for, including political and economic instability, possible expropriation, regulatory changes, changes in currency exchange rates, difficulties in protecting our intellectual property, changes in tax rates and structures, and collection of accounts receivable. Further, our international markets are served primarily by non-exclusive resellers and distributors who themselves may be severely affected by economic or market changes within a particular country or region. Our international sales are subject to the requirements of the U.S. Foreign Corrupt Practices Act, and similar laws of other countries. For sales within the European Union, our products must comply with the Restriction on Hazardous Substances Directive (RoHS) and Waste from Electrical and Electronic Equipment (WEEE) requirements, any failure of which could result in fines, product seizures, or injunctions against sale.
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Our products are subject to export controls and shipments of our products sometimes require a license from the U.S. government.
We are subject to U.S. laws and regulations governing international trade and exports, including, but not limited to the Export Administration Regulations (EAR), International Traffic in Arms Regulations (ITAR), and trade sanctions against embargoed countries and destinations administered by the Office of Foreign Assets Control (OFAC) of the U.S. Department of the Treasury. Under these laws and regulations, we are responsible for obtaining all necessary licenses or other approvals, if required, for exports of hardware, software and technology, as well as the provision of service. For some of our products subject to EAR, the requirement for a license is dependent on the type and end use of the product, the final destination, the identity of the end user, and whether a license exception might apply. Obtaining export licenses can be difficult and time-consuming, and in some instances a license may not be available on a timely basis or at all.
In fiscal 2011, we learned that some of our products may have been exported or re-exported in violation of U.S. export laws. Consequently, we launched an internal investigation of our export-related activities, and reported the results of the investigation to the U.S. government. To date, the U.S. government has not taken action against the Company, but has issued the Company a number of warning letters and a portion of the U.S. government’s review of the matter remains open. If the U.S. government determines that we have failed to comply with one or more export control laws or trade sanctions, we could be subject to various 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.
The market for our products is highly competitive and many of our competitors have greater resources than we do.
The market for networking equipment is highly competitive and dynamic, has been characterized by rapid technological changes and shifting customer requirements, and has seen a worldwide migration from existing circuit technology to the new packet-based technologies. We compete directly, both internationally and domestically, with many different companies, some of which are large, established suppliers of end-to-end solutions, such as Alcatel-Lucent, Avaya, Cisco Systems, Juniper Networks, and Siemens AG. In addition to some of these large suppliers, a number of other smaller companies are targeting the same markets as we are. Particularly, in the unified communications market, Audiocodes Limited and Dialogic Corporation provide competitive solutions and are also partners with Microsoft.
Our larger competitors have significantly greater financial, marketing and technical resources than we have, offer a wider range of networking products than we offer, and can often provide a complete network solution. They are often able to devote greater resources to the development, marketing and sale of their products and to use their equity or significant cash reserves to acquire other companies with technology and/or products that compete directly with ours. They often can compete favorably on price because their sales volume and broad product lines can allow them to make discounted sales while maintaining acceptable overall profit margins. The smaller companies have more ability than we do to focus their resources on a particular product development unencumbered by the requirements to support an existing product line. As a result of the flexibility of their market strategies, our competitors may be able to obtain strategic advantages that may adversely affect our business, financial condition or results of operations.
In addition, the networking equipment market has seen the constant introduction of new technologies that have reduced the value of older technology solutions. This has created pricing pressure on older products while increasing the performance expectations of newer networking equipment. Moreover, broadband technology standards are constantly evolving, and alternative technologies or technologies with greater capability are constantly introduced and sought by our customers. It is possible that the introduction of other technologies will either supplant our current technologies and technologies we have in development, or will require us to significantly lower our prices in order to remain competitive. To remain competitive, we must continue to evolve our product lines to meet the ever-changing technology needs of the networking market while ensuring that they can be sold at a competitive price. We also must enhance our Promina product line to provide needed features that increase its overall value for the customer while keeping the price competitive. Due to the competitive nature of the market and the relative age of our Promina product offerings as well as the competitive pressure affecting all our products, we may not be able to maintain prices for them at levels that will achieve profitability. Also, we may not be successful in completing the development of, or commercializing, products under development.
If we are unable to sign competitive resale partners, our future product and service revenue will be adversely affected.
Our international sales, other than those made to foreign ministries of defense (MoDs), are made through indirect channels that include distributors and resellers worldwide, and our business strategy includes leveraging resale partners in the United States. In addition, many of our target customers, including the government, rely on systems integrators to incorporate new equipment or services into their networks. While we have begun the process of identifying and signing software application, system integrator and OEM or resale partners, more partners are necessary in these areas for us to be successful. We may also need to pursue strategic partnerships with vendors who have broader technology or product offerings in order to compete with the end-to-end solution providers. In addition, many of the enterprise markets we are pursuing require a broad network of resale partners in order to achieve effective distribution. Failure to sign up new reseller and strategic partners, or to implement business processes and services needed to adequately support the distribution channel, could affect our ability to grow overall revenue.
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Our sales through systems integrators typically involve the use of our products as components of a larger solution being implemented by the systems integrator. In these instances, the purchase and sale of our product is dependent on the systems integrator, who typically controls the timing, prioritization, and implementation of the project. Project delays, changes in priority, or solution re-design decisions by the systems integrator can adversely affect our product sales.
Our products have long sales cycles, making it difficult to predict when a customer will place an order and when to forecast revenue from the related sale.
Many of our products are complex and represent a significant capital expenditure to our customers. The purchase of our products can have a significant effect on how a customer designs its network and provides services either within its own organization or to an external customer. Consequently, our customers often engage in extensive testing and evaluation of products before purchase. There are also numerous financial and budget considerations and approvals that a customer often must obtain before it will issue a purchase order. As a result, the length of our sales cycle can be quite long, extending beyond twelve months in some cases. We have little visibility into the sales pipelines of resellers, which adds to the difficulty of accurately forecasting revenue. In addition, our customers, including resellers, often have the contractual right to delay scheduled order delivery dates with minimal penalties and to cancel orders within specified time frames without penalty, which makes it difficult to predict whether or not an order may actually ship. We often must incur substantial sales and marketing expense to ensure a purchase order is placed. If orders are not placed in the quarter forecasted, our sales may not meet forecast and revenue may be insufficient to meet expenses.
Because it is difficult for us to accurately forecast sales, particularly within a given time frame, we face a risk of having too much or too little inventory.
Typically, the majority of our revenue in each quarter has resulted from orders received and shipped in that quarter. While we do not believe that backlog is necessarily indicative of future revenue levels, our customers’ ordering patterns and the possible absence of backlogged orders create a significant risk that we could carry too much or too little inventory if orders do not match forecasts. Rather than base forecasts on orders received, we have been forced to schedule production and commit to certain expenses based more upon forecasts of future sales, which are difficult to predict. We are generally liable for excess component inventory and unsold product assemblies that our contract manufacturer orders or assembles based on our forecasts. If large orders do not close when forecasted or if near-term demand weakens for the products we have available to ship, we will have expenses with no corresponding revenue and our operating results for that quarter or subsequent quarters would be materially adversely affected. At the same time, we may face shortages that preclude us from fulfilling orders that are not in our forecast, as a result of lead times for component procurement and manufacturing. If there is an unexpected decrease in demand for certain products or there is an increased risk of inventory obsolescence, which can happen relatively quickly due to rapidly changing technology and customer requirements, adjustments may be required to write down or write off certain inventory, which would adversely affect our operating results.
Delays in government programs or other customer ordering could cause products or product versions to become obsolete sooner than forecasted, which could result in substantial write-downs.
We maintain inventory of various products and components in order to compensate for lead times in parts ordering and product manufacturing, as well as to avoid shortages of parts that are difficult to procure or no longer available. Due to our long sales cycle, customer orders may span release schedules for new versions of our products, particularly if there are delays in customer ordering. As a result, orders we expected to fulfill with one version may become orders for the next version, which could result in us holding obsolete inventory for the earlier version. We have significant unreserved inventory balances on hand, including inventory that is owned by our contract manufacturer but for which we are responsible if it is unused. Substantial charges for the write-down or write-off of obsolete inventory would adversely affect our operating results.
If we are unable to attract, recruit and retain key personnel, then we may not be able to successfully manage our business.
Our success continues to be dependent on our being able to attract and retain highly skilled engineers, managers and other key employees. In most cases, we face significant competition for the most qualified personnel for new positions and to replace departing employees. If we are not able to continue to attract, recruit and retain key personnel, particularly in engineering and sales and marketing positions, we may be unable to meet important company objectives such as product delivery deadlines and sales targets.
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Over the past several years, we have restructured our organization which may cause disruptions to our business.
In fiscal 2012, we implemented a restructuring that included significant workforce reductions. In fiscal 2011, we reorganized a number of functions and sought ways to reduce costs and improve efficiencies, such as changes to our internal business processes, transitions to different vendors or service providers, and outsourcing of certain functions. These activities are subject to a number of risks, such as diversion of management time and resources; diminished ability to respond to customer requirements, both as to products and services; and disruption of our engineering and manufacturing processes. Further, despite our efforts, the savings we expect from these actions may not be achieved, or may be achieved only after an initial increase in costs. Problems resulting from these reorganization activities, such as potential challenges maintaining our business systems and operating infrastructure, could have a material adverse effect on our business, results of operations, and financial condition, particularly if coupled with a failure to achieve the expected cost savings. In addition, changes to our business processes may require revisions to our internal controls, and may make it more difficult for us to achieve certification of our internal control over financial reporting, if required.
Our ability to ship our products in a timely manner is dependent on the availability of component parts and other factors.
Several key components of our products are available only from a single source, including certain integrated circuits and power supplies. Depending upon the component, there may or may not be alternative sources or substitutes. Some components are purchased through purchase orders without an underlying long-term supply contract, and some components are in short supply generally throughout the industry. If a required component were no longer available, we might have to significantly reengineer the affected product. Further, variability in demand and cyclical shortages of capacity in the semiconductor industry have caused lead times for ordering parts to increase from time to time. Delays may occur as a result of factors beyond our control, including weather-related delays and other events. If we encounter shortages or delays in receiving ordered components or if we are not able to accurately forecast our ordering requirements, we may be unable to ship ordered products in a timely manner, resulting in decreased revenue. In some instances, our product development efforts are based on component parts, such as integrated circuits, still under development by third-parties. Any delay or failure by the third-party provider to complete and release such a component, which is generally beyond our control, would cause delays or an inability for us to complete and ship the product that is based on the component, which would adversely affect our revenue.
Generally, our customer contracts allow the customers to reschedule delivery dates or cancel orders within certain time frames before shipment without penalty and outside those time frames with a penalty. Because of these and other factors, there are risks of excess or inadequate inventory that could negatively affect our expenses, revenue and earnings. Additionally, defense expedite (DX)-rated orders from the federal government, which by law receive priority, can interrupt scheduled shipments to our other customers.
We outsource our product manufacturing.
We outsource our product manufacturing, including most assembly and structural test, as well as functional test, systems integration, and order fulfillment functions, though we generally remain liable for inventory of components and finished material.
Any difficulties or failures to perform by our contract manufacturers could cause delays in customer product shipments or otherwise negatively affect our results of operations. We also share responsibility for inventory management and production planning with our contract manufacturers, which may increase the risks of carrying too much or too little inventory of either component parts or manufactured product. We have agreed to compensate our contract manufacturers in the event of termination or cancellation of orders, discontinuance of product, or excess material. Also, should our principal contract manufacturer in some future period decide not to renew our contract with it, or should we experience any failure to perform or other difficulties with our principal contract manufacturer, it would be difficult for us to quickly transfer our manufacturing requirements to another vendor, likely causing substantial delays in customer product shipments and adversely affecting our revenue and results of operations.
As inventory ages, we may be required to make substantial deposits with or purchases from our contract manufacturer.
As part of our arrangement with our principal contract manufacturer, we are required to make deposits on certain purchased raw materials or certain work-in-process items that are held for greater than 90 days, although the contract manufacturer must make efforts to minimize our liability for this inventory, including returning materials to suppliers, canceling orders with suppliers or using materials to manufacture product for its other customers. Raw material and in-process inventories that are unused and have been held for more than nine months require us to take ownership, or, at a minimum, pay a management fee assuming there is future forecasted demand for those inventories. Further, if anticipated demand for inventories does not materialize in future periods, we are required to take ownership of those associated inventories. We have substantial amounts of inventory at our principal contract manufacturer, and have already made significant deposits on some of the inventory. Additional deposits may be required in the future and if the inventory continues to remain on hand, we may be required to purchase the inventory underlying the deposit and adjustments may be required to write down or write off this inventory, any of which would adversely affect our operating results.
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Our intellectual property rights may not be adequate to protect our business.
Our future success depends in part upon our proprietary technology. Although we attempt to establish and maintain rights in proprietary technology and products through patents, copyrights, and trade secrets laws, we cannot predict whether such protection will be adequate or whether our competitors can develop similar technology independently without violating our proprietary rights. As competition in the communications equipment industry increases and the functionality of the products in this industry further overlap, we believe that companies in the communications equipment industry may become increasingly subject to infringement claims. We have received and may continue to receive notice from third parties, including some of our competitors, claiming that we are infringing their patents or their other proprietary rights. To settle such claims, we may enter into licensing arrangements requiring us to pay a royalty to the third party. We cannot predict whether we will prevail in any litigation over third-party claims or that we will be able to license any valid and infringed patents on commercially reasonable terms. Any of these claims, whether with or without merit, could result in costly litigation, divert our management’s time, attention and resources, delay our product shipments or require us to enter into royalty or licensing agreements. In addition, a third party may not be willing to enter into a royalty or licensing agreement on acceptable terms, if at all. If a claim of product infringement against us is successful and we fail to obtain a license or develop or license non-infringing technology, we may be unable to market the affected product.
Although we have a number of patent applications pending, we cannot guarantee that any will result in the issuance of a patent. Even if issued, the patent may later be found to be invalid or may be infringed without our knowledge. Our issued patents might not be enforceable against competitive products in every jurisdiction, and it is difficult to monitor unauthorized use of our proprietary technology by others. Regardless of our efforts to protect our intellectual property, the rapidly changing technologies in the networking industry make our future success primarily a function of the skill, expertise and management abilities of our employees. Nonetheless, others may assert property rights to technologies that are relevant to our currently marketed products or our products under development. If our protected proprietary rights are challenged, invalidated or circumvented, it could have a material adverse effect on our competitive position and sales of our products. Conversely, if other parties are infringing our patents, we may pursue claims against them in order to yield value attributable to our technology. Such claims could involve costly litigation, could divert our management’s time and resources, and could result in counterclaims challenging rights to other technology used by us.
We rely on technologies licensed from third parties.
For each of our product lines, we license some of our technology from third parties. Some of these licenses contain limitations on distribution of the licensed technology, are limited in duration, or provide for expiration upon certain events, such as a change in control of the company. If the relevant licensing agreement expires or is terminated without our being able to renew that license on commercially reasonable terms or if we cannot obtain a license for our products or enhancements on our existing products, we may be unable to market the affected products or may be liable for monetary damages. Our license arrangements are generally not exclusive to us. Our license for a third-party technology, or any exclusivity thereto, may be limited in territory or scope. We generally pay an ongoing royalty for licensed technology, which can restrict our ability to manage costs of the product, leaving us more vulnerable to competition from others, including potentially the licensor itself. For many of these technologies, we rely on the third-party providers to update and maintain the technology, fixing errors and adding new features. If the third-party providers do not adequately update and maintain these technologies, whether due to changes in their product direction, their own financial difficulties, or other reasons, we would need to seek alternative means to fulfill the ongoing requirements for our products that incorporate the third-party technology. If we are unable to find alternative means of fulfilling the ongoing requirements, we may be unable to market the affected products.
We outsource some of our product development activities, which carries inherent risks such as reduced ability to control the timing and quality of the work product, uncertain continuity and availability of skills and knowledge, difficulties of managing and integrating the third-party development, and potential disputes over intellectual property. To the extent we use parties located in overseas jurisdictions, the intellectual property provided to or developed by the third party may, depending on the laws of the jurisdiction, be subject to weaker or significantly different intellectual property protection. In using third parties for product development, we must share with them and will receive from them various intellectual property, which increases the risk of misuse of our intellectual property, as well as the risk that the resulting product might contain items that infringe the intellectual property rights of others.
Many of our sales depend on our achieving third-party certifications for our products.
In several markets for our products, we must achieve various certifications from third parties in order to obtain sales of those products. For example, sales of unified communications products often require certification of interoperability with other vendors’ products; sales to the federal government of products destined for use in military applications must be certified by the JITC; and international sales may depend on standards established by telecommunications authorities in various countries. These certification processes can be lengthy and often require the commitment of another vendor’s or agency’s personnel and test equipment, and we compete with other suppliers for these resources. Even after achieving a particular certification, we may be required to re-certify our products as technologies evolve and other vendors’ products are updated. Any delays in obtaining these certifications or failure to obtain these certifications could adversely affect our ability to sell our products.
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The market for some of our products depends on the availability and demand for other vendors’ products.
Some of our products, particularly those addressing the unified communications market, are designed to function with other vendors’ products. In these cases, demand for our products is dependent upon the availability, demand for, and sales of the other vendors’ products, as well as the degree to which our products successfully interoperate with the other vendors’ products and add value to the solution being provided to the customer. If the other vendors change the design of their products, delay the issuance of new releases, fail to adequately market their products, or are otherwise unsuccessful in building a market for their products, the demand for our products will be adversely affected.
We face risks associated with changes in regulations and tariffs, including regulation of the Internet.
Changes in domestic and international telecommunications equipment requirements could affect the sales of our products. In the United States, our products must comply with various FCC requirements and regulations. In countries outside of the United States, our products must sometimes meet various requirements of local telecommunications authorities. Changes in tariffs or failure by us to obtain timely approval of products could affect our ability to market the affected products.
New restrictions on trade, such as in response to transfers of jobs from the United States to lower-cost foreign locations, could limit our ability to purchase components from, or outsource functions to, foreign entities, which would likely make it more difficult to maintain competitiveness in the global market. As a result of our current concentration of business to the federal government, we are more sensitive to these trade restrictions, whether tariffs, incentives, or government purchasing requirements such as the “Buy American Act,” than we would be with a more diversified customer base.
Changes in other laws and regulations, or changes in their interpretation or enforcement, such as confidentiality requirements under the federal privacy laws, California’s state wage and hour laws, or employment regulations in foreign jurisdictions, impose additional costs and potential liabilities on us.
We are exposed to fluctuations in the exchange rates of foreign currency.
As a global concern, we face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and could have a material adverse affect on our financial results. We use foreign exchange contracts to hedge significant accounts receivable and intercompany account balances denominated in foreign currencies. Although we have established foreign exchange contracts for non-dollar denominated sales and operating expenses in the United Kingdom, France, and Japan, exposures remain for non-dollar denominated operating expenses in Asia and Latin America. We will continue to monitor our exposure and may hedge against these or any other emerging market currencies as necessary. Market value gains and losses on hedge contracts are substantially offset by fluctuations in the underlying balances being hedged.
We are exposed to fluctuations in the market values of our investment portfolio.
Although we have not experienced any material losses on our cash, cash equivalents and short-term investments, future declines in their market values could have a material adverse effect on our financial condition and operating results. Our investment policy requires our investments to have a credit rating of single-A or better, with asset backed securities rated triple A. If any of these issuers default on their obligations, or their credit ratings are negatively affected by liquidity, credit deterioration or losses, financial results, or other factors, the value of our cash equivalents and short-term investments could decline and result in a material impairment.
The location of our facilities subjects us to the risk of earthquake and floods.
Our corporate headquarters, including most of our research and development operations, are located in the Silicon Valley area of Northern California, a region known for seismic activity. These facilities are located near the San Francisco Bay where the water table is quite close to the surface and where tenants in nearby facilities have experienced water intrusion problems. A significant natural disaster, such as an earthquake or flood, could have a material adverse affect on our business, operating results, and financial condition.
Any material weakness or significant deficiency identified in our internal controls could have an adverse effect on our business.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies evaluate and report on their internal control structure and procedures over financial reporting. In the third quarter of fiscal 2012, we completed a review of our historical practices with respect to inventory valuation. That review indicated that during fiscal 2011 and in the first half of fiscal 2012 we did not consistently follow our accounting policies for determining inventory valuation. Specifically, we did not maintain effective controls to ensure that the process to determine the correct classification of certain assets as inventory not expected to be consumed within the next 12 months complied with our accounting policies. As a result of this significant deficiency in our internal controls, we reclassified prior period inventory and other non-current assets in our fiscal 2012 third quarter quarterly report on Form 10-Q, and in this fiscal 2012 annual report on Form 10-K. Other significant deficiencies or material weaknesses could arise that would be required to be reported in the future. Due to the minimal number of people that we currently employ, there is a risk that we may not be able to maintain adequate segregation of duties, which would be a weakness in our internal controls. If the Company fails to maintain an effective system of internal controls, it may not be able to accurately report its financial results or prevent fraud. In addition, the evaluation process and any required remediation, if applicable, may increase our accounting, legal and other costs, and may divert management resources from other business objectives and concerns.
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ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2.
PROPERTIES
NET is headquartered in Fremont, California. In fiscal 2011, we executed a five-year extension of the facility lease for our headquarters building, totaling 97,747 square feet, which now runs through the third quarter of fiscal 2017.
NET and our subsidiaries lease facilities in Illinois, primarily for research and development, and in New Jersey, China, and Hong Kong, for sales and final assembly and test of products. We also lease offices, primarily for sales and service, at other locations in the United States, the United Kingdom, France, China, Australia, Japan and Dubai.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
A subsidiary of the Company, Quintum Technologies, LLC (Quintum), is party, by interpleader, to three related lawsuits in Greece filed by Lexis SA, a former distributor of Quintum products in Greece. The initial interpleader lawsuit was filed October 26, 2006, at the Multimember First Instance Court of Athens. At hearings in January and February 2012, the underlying lawsuits were cancelled due to the fact that the originating plaintiffs waived their rights against Lexis prior to the hearing. However, Lexis has not yet formally waived its rights against Quintum, and so hearings are still on calendar on the matter between Lexis and Quintum, now scheduled for January 2015. By way of background, the lawsuits allege that a set of hardware and software products acquired by Lexis for a customer failed to perform as a system. The products include Quintum’s hardware product and a software product by another vendor. The damages sought include a refund of amounts paid for the purchase of the hardware and software, totaling approximately $98,000, compensation for real and moral damages totaling approximately $4.4 million, and monetary damages totaling approximately $3.6 million for non-delivery of services that were to be delivered through the system. The Company has not accrued any amounts related to the claim, as it believes that a negative outcome is not probable.
In addition to the above, we are involved in various legal proceedings from time to time in the normal course of our business.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
For a discussion of securities authorized for issuance under equity compensation plans, see notes 9 and 10 to the consolidated financial statements.
(c) Issuer Purchases of Equity Securities:
Issuer Purchases of Equity Securities during the quarter ended March 30, 2012:
(in thousands, except shares and per share amounts)
(1)
During the quarter ended March 30, 2012, 26,911 shares were acquired directly from employees as payment of tax withholding obligations upon vesting of restricted stock awards.
Market Price
NET’s common stock is traded on The NASDAQ Stock Market, LLC under the symbol “NWK.” Until April 23, 2009, NET’s common stock was listed on the New York Stock Exchange. The following table sets forth, for the quarterly periods indicated, the high and low sale prices of our common stock:
At May 25, 2012, there were approximately 383 registered stockholders of record of NET. Because brokers and other institutions hold many of our shares on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.
NET has never declared or paid dividends on our capital stock and does not intend to pay dividends in the foreseeable future. Our convertible debt trades in the over-the-counter market.
Information regarding equity compensation plans will be contained in the Proxy Statement in the section captioned “Equity Compensation Plan Information” and is incorporated herein by reference.
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Stock Performance Graph
The graph depicted below shows NET’s stock price as an index assuming $100 invested over the five year period beginning on April 2, 2007, along with the composite prices of companies listed in the S&P 500 Index and NASDAQ Telecommunications Index. All values assume reinvestment of the full amount of all dividends.
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ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The following selected financial information has been derived from the audited consolidated financial statements. The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes thereto included elsewhere in this Form 10-K.
The information presented below reflects the impact of certain significant transactions, including the acquisition of Quintum in fiscal 2008 at a total cost of $45.0 million, and the impairment of goodwill and long-lived assets in fiscal 2009 totaling $44.3 million, which makes a direct comparison difficult between each of the last five fiscal years.
(in thousands, except per share amounts)
ITEM 7.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying notes included in this Form 10-K. Statements contained in this discussion that are not historical facts are forward-looking statements within the meaning of the federal securities laws that relate to future events or our future financial performance. A forward-looking statement may contain words such as “plans,” “hopes,” “believes,” “estimates,” “will,” “continue to,” “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 identified in this discussion. 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 discussion except as required by law. Investors should carefully review the risk factors described in this document along with other documents the Company files from time to time with the Securities and Exchange Commission (SEC).
Critical Accounting Policy Judgments 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.
Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and the Audit Committee has reviewed the foregoing disclosure. Changes in estimates used in these and other items could have a material effect on our financial statements.
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We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements:
Revenue Recognition: The Company derives revenue primarily from the sales of hardware, software, services, post-contract support (PCS), and professional services. PCS typically includes unspecified software updates and upgrades on an if-and-when available basis and telephone and internet access to technical support personnel.
In October 2009, the Financial Accounting Standards Board (FASB) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance. In October 2009, the FASB also amended the standards for multiple deliverable revenue arrangements to:
(i)
provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the arrangement consideration should be allocated among its elements;
(ii)
require an entity to allocate the revenue using estimated selling prices (ESP) of the deliverables if there is no vendor specific objective evidence (VSOE) or third party evidence of selling price (TPE); and
(iii)
eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.
This new accounting guidance became applicable to the Company beginning the first quarter of its fiscal 2012. The Company adopted this guidance for transactions that were entered into or materially modified on or after March 26, 2011 using the prospective basis of adoption.
Product revenue is recognized when the Company has a contract with its customer, the product has been shipped as required by the contract and risk of loss has passed to its customer, the price is fixed or determinable, and the collectability of the related receivable is probable. If the customer has a right of acceptance and the Company has not yet obtained acceptance, revenue is deferred until the terms of acceptance are satisfied. When product revenue is deferred, the Company also defers the associated cost of goods until the revenue is recognized. The Company recognizes service revenue upon completion of the service or, for ongoing services such as PCS, ratably over the period of the contract.
Revenue on sales through resellers is recognized upon transfer of title to the reseller. Many of the sales to the Company’s resellers are based upon firm commitments from their end customer; as a result, these resellers carry little or no inventory of NET products. For the Company’s Promina, VX, NX and UX products, NET’s customers generally do not have the right to return the equipment. For the Company’s Tenor 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 new revenue recognition guidance does not generally change the units of accounting for the Company’s revenue transactions. All of the products and services continue to qualify as separate units of accounting. The Company analyzes all of its products, software and services and considers the features and functionalities of the individual elements and the stand-alone sales of those individual components among other factors, to determine which elements are essential or non-essential to the overall functionality of the networking equipment. The Company’s core software (herein after referred to as ‘essential software’) is integrated with hardware and is essential to the functionality of the networking equipment. The Company’s sale of additional software provides increased features and functions, but is not essential to the overall functionality of the networking equipment (herein after referred to as ‘non-essential software’).
For transactions entered into prior to the first quarter of fiscal 2012, the Company recognized revenue based on the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 985-605 (formerly referred to as Statement of Position No. 97-2, Software Revenue Recognition). In accordance with ASC 985-605, the Company utilized the residual method to determine the amount of product revenue to be recognized. Under the residual method, the fair value of the undelivered elements, such as PCS, is deferred and the remaining portion of the arrangement consideration is recognized as product revenue. VSOE of fair value is limited to the price charged when the same element is sold separately. VSOE of fair value is established for PCS and professional services based on the volume and pricing of the stand-alone sales within a narrow range. The fair value of the post-contractual support is recognized on a straight-line basis over the term of the related support period, which is typically one month to three years.
For transactions entered into or materially modified on or after the beginning of the first quarter of fiscal 2012, the total arrangement fees were allocated to all the deliverables based on their respective relative selling prices. The relative selling price is determined using VSOE when available. When VSOE cannot be established, the Company attempts to determine the TPE for the deliverables. TPE is determined based on competitor prices for similar deliverables when sold separately by the competitors. Generally the Company’s product offerings differ from those of its competitors and comparable pricing of its competitors is often not available. Therefore, the Company is typically not able to determine TPE. When the Company is unable to establish selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement fees. The ESP for a deliverable is determined as the price at which the Company would transact if the products or services were sold on a stand-alone basis.
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The Company has been able to establish VSOE for its PCS and professional services based on the volume and the pricing of the stand-alone sales for these services within a narrow range.
The Company has determined the ESP of its products and services for which VSOE has not been established based on an analysis of (i) the list price, which represents a component of the Company’s current go-to market strategy, as established by senior management taking into consideration factors such as geography and the competitive and economic environment and (ii) an analysis of the historical pricing with respect to both the Company’s bundled and stand-alone sales of each product or service.
The Company’s multiple element arrangements may include non-essential software deliverables that are subject to the industry specific software revenue recognition guidance. The revenue for these multiple element arrangements is allocated to the non-essential software deliverables and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the new revenue accounting guidance. As the Company has not been able to obtain VSOE for all of the non-essential software deliverables in the arrangement, revenue allocated to such non-essential software elements is recognized using the residual method in accordance with industry specific software revenue recognition guidance as the Company was able to obtain VSOE for the undelivered elements bundled with such non-essential software elements. Under the residual method, the amount of revenue recognized for the delivered non-essential software elements equaled the total allocated consideration less the VSOE of any undelivered elements bundled with such non-essential software elements.
The change from the residual to the relative selling price method did not have a material impact on the allocation of revenue to the arrangement deliverables, nor did the Company change its assessment of the deliverables contained within its revenue arrangements. The adoption of the new revenue accounting guidance was not material to the Company’s financial results for the year ended March 30, 2012.
Allowance for Sales Returns: A reserve for sales returns is established primarily for our reseller and distributor customers, based on actual historical product returns. If the actual future returns differ from historical levels, our revenue could be adversely affected.
Allowance for Doubtful Accounts: The allowance for doubtful accounts receivable is based on our assessment of the collectability of specific customer accounts and the aging of accounts receivable. If there is a deterioration of a major customer’s credit worthiness or actual defaults are higher than our historical experience, we may have to increase our allowance for doubtful accounts receivable, and our operating expenses could be adversely affected. Credit losses have historically been within our expectations and the allowances for doubtful accounts receivable that were established.
Inventory and Contract Manufacturer Liabilities: Under an agreement with our primary contract manufacturer, Plexus Corp. (Plexus), 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. The term of our agreement with Plexus currently runs to December 31, 2012, with automatic renewal for additional one-year terms unless either party gives notice of intent not to renew, and subject to either party’s right to terminate upon six month’s notice.
At March 30, 2012, our deposit on inventory held by Plexus was $ 2.3 million, of which $1.3 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 consolidated balance sheets.
We value inventory at the lower of cost (first-in, first-out) or market. If we believe that demand no longer allows us to sell our inventory above cost, or at all, we establish reserves to write down inventory to market value or write off excess or obsolete inventory. To the extent that a severe decline in forecasted demand occurs, or we experience a higher incidence of inventory obsolescence due to rapidly changing technology and customer requirements, we may incur significant charges for excess inventory. We use estimates to allocate manufacturing overhead to inventory which is expensed when the inventory is sold to the end customer.
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Long-lived assets: Depreciable assets are assigned estimated lives ranging from three to ten years. We review long-lived assets, including intangible assets with finite lives, property and equipment, and other assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Conditions that would necessitate an impairment assessment might include a significant decline in the market price of an asset or asset group, a significant adverse change in the extent or manner in which an asset or asset group is being used, the loss of legal ownership or title to the asset, significant negative industry or economic trends or the presence of other factors that would indicate that the carrying amount of an asset or asset group is not recoverable. We consider a long-lived asset to be impaired if the estimated undiscounted future cash flows resulting from the use of the asset and its eventual disposition are not sufficient to recover the carrying value of the asset. If we deem an asset to be impaired, the amount of the impairment loss represents the excess of the asset’s carrying value compared to its estimated fair value.
Warranty Accruals: We warrant 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. Our 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.
Stock-based Compensation: We recognize stock-based compensation expense for all share-based payment awards including employee stock options and restricted stock awards. We value stock-based compensation expense for expected-to-vest stock-based awards under the single-option approach and we amortize stock-based compensation expense on a straight-line basis, net of estimated forfeitures. We recognize the value of the portion of the award that is ultimately expected to vest over the requisite service periods in our consolidated statements of operations.
We estimate the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. The fair value is amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Our computation of expected volatility is based on historical volatility commensurate with the expected term of the options. The risk-free interest rate used in the Black-Scholes option-pricing formula is based on the implied yield currently available on U.S. Treasury securities with an equivalent remaining term commensurate with the expected term of the options. The expected dividend assumption is based on our current expectation that we will not pay out cash dividends in the foreseeable future. We estimated the expected term of options granted in fiscal 2012, 2011 and 20010 using vesting periods of awards and historical data such as past experience and post-vesting cancellations. We believe these calculations provide reasonable estimates of expected life for stock-based awards to employees.
Deferred Taxes: We determine our income taxes in each of the jurisdictions in which we operate which involves estimating our actual current tax expense together with assessing temporary differences resulting from recognition of items for income tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from taxable income during the carryback period or in the future, and to the extent we believe that recovery is not likely, we must establish a valuation allowance. Our most significant deferred tax assets are net operating losses, for which we provide a valuation allowance based on our estimation of the likelihood of recovery. FASB ASC Topic 740, Income Taxes, provides for the recognition of deferred tax assets if realization of such assets is more likely than not to occur. Based upon the weight of available evidence, which included the Company’s historical operating performance and reported cumulative net losses, we provided a full valuation allowance against our U.S. and most of our foreign net deferred tax assets. There is no valuation allowance against our UK deferred tax assets. We reassess the need for our valuation allowance on a quarterly basis.
Tax years from 1998 in the U.S. and 2006 in our primary foreign jurisdictions remain open for examination. Although the timing of resolution and closure of audits is highly uncertain, we do not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next twelve months.
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Results of Operations
The following table sets forth selected data derived from our consolidated statements of operations expressed as a percentage of revenue for the periods presented:
Overview and highlights
●
We are transitioning our product line to address unified communications and other new telecommunications opportunities. Sales of our UX Series platform, including the UX1000, which was introduced in the third quarter of fiscal 2012, have been increasing, but the total increase in UX Series product sales in fiscal 2012 was not enough to offset the decline in sales of our Promina and other multi-service products and our VoIP-based VX Series product. Product revenue from our Enterprise business increased 45% from the prior fiscal year while product revenue from our government business decreased 59% from the prior fiscal year.
●
Total revenue decreased in fiscal 2012 due mostly to lower sales to government customers. Sales to the government sector have declined substantially in recent quarters, as demand for our Promina and VX Series products has waned and our newest products are not currently targeted to the government. Certain features required by the government are not planned for the UX Series until 2013, and sales of the UX Series to the government will require marketing of the product for new solutions within the government that were not targeted by our prior products.
●
Our sector mix and our mix of product sales fluctuate quarter to quarter. Our newer products have not achieved broad market acceptance, so large individual sales can have a significant effect on our mix of product sales. Also, spending by government customers fluctuates based on budget allocations, the timely passage of the annual federal budget, and the timing of specific programs and purchasing for those programs. In the fourth quarter of fiscal 2012, more than three-fourths of our product revenue came from our next generation switching platforms (the UX Series, VX Series and Tenor products), which are designed primarily for enterprise customers. The following table shows elements of our sector mix and our mix of product sales:
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●
Product margin was down as a result of reduced sales and a changing mix of products. With reduced sales, we are unable to take advantage of economies of scale, and have also had to take reserves for excess or obsolete inventory. In addition, we had achieved a higher gross margin on our legacy products, which make up a declining portion of our revenue mix, compared to the gross margin for our more recently introduced products. In part, this is because the more recently introduced products have not yet benefitted from cost reduction efforts or volume purchasing.
●
Service margin was up due to higher service revenue and changes in service delivery arrangements. Our arrangement with CACI International Inc. (“CACI”) for the sharing of maintenance and other services expired in December, 2010. We now perform these services ourselves, with a relatively small increase in cost, and no longer have the cost of remitting to CACI any payment based on the revenue associated with these services. In addition, service margins benefitted from the effect of workforce reductions in conjunction with the corporate restructuring plan implemented in the fourth quarter of fiscal 2012.
●
Expense levels were generally consistent with prior periods. Operating expense in fiscal 2012 decreased 2.2% from the prior year, due largely to lower stock compensation expense and reduced charges for our headquarters facility lease. The effect of these cost reductions was partially offset by restructuring charges incurred in the fourth quarter of fiscal 2012, during which we implemented workforce reductions as part of an effort to bring the Company’s operating expenses more in line with revenues and preserve capital resources. Going forward, we expect additional savings due to the restructuring plan implemented in the fourth quarter of fiscal 2012.
Revenue
Fiscal 2012 compared to fiscal 2011
Total revenue decreased in fiscal 2012, due to a $17.8 million decline in product revenue from government customers, across product lines. The decrease was partially offset by a $7.0 million increase in product sales to commercial customers and also by higher service and other revenue. On a product-line basis, the decrease in product revenue was mostly due to reduced sales of our Promina and VX Series products (which are sold primarily to government customers), although international sales of VX Series products were up slightly. Sales of our UX series products, the first of which was introduced in the third quarter of fiscal 2011, increased in fiscal 2012. We expect our product and sector mix to continue to change as we shift our focus to new communications technologies for enterprise businesses, such as unified communications.
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Service and other revenue increased in fiscal 2012 due primarily to an increase in maintenance contracts sold with new products. 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.
Fiscal 2011 compared to fiscal 2010
Total revenue decreased in fiscal 2011, due to a $17.4 million decline in sales of NX1000 and Promina products to government customers. The decrease was offset in part by higher sales, by $3.3 million, of VX Series products, to both government and commercial customers and, to a lesser extent, by sales to commercial customers of UX Series products, which were introduced mid-year. Sales associated with the basic VoIP applications that were a large part of the traditional Quintum business declined.
Service and other revenue decreased in fiscal 2011, principally due to the recognition in fiscal 2010 of $1.3 million of previously deferred service and other revenue, with no similar deferred revenue in fiscal 2011.
Gross margin
Fiscal 2012 compared to fiscal 2011
Total gross margin decreased in fiscal 2012 due to a drop in product margin as a result of reverse economies of scale on lower product revenue, a change in product mix, and inventory reserve charges. The decrease in product margin was partially offset by an increase in service and other margin.
Product gross margin was negatively affected by economies of scale, as a lower amount of product revenues was available to absorb manufacturing overhead. The change in product mix contributed to lower product margin, in part because the more recently introduced products have not yet benefitted from on-going cost reduction efforts or volume purchasing. Product margin was also affected by inventory reserve charges. Our contract manufacturer holds inventory on our behalf. As inventory held by the contract manufacturer ages, we are required by contract to make deposits on the inventory, and if it continues to remain on hand, to purchase the inventory underlying the deposit. We may subsequently need to write down or write off the inventory. Inventory reserve charges for fiscal 2012 and fiscal 2011 were $2.1 million and $550,000, respectively. Fiscal 2012 inventory reserve charges of $2.1 million in large part reflected end-of-life announcements issued in fiscal 2012 for some of the Promina product line as well as changes in our expectations regarding the useful lives of certain inventory components for the Promina product line.
Service and other gross margin improved due largely to the termination of the revenue sharing arrangement with our former service partner, CACI, late in fiscal 2011. We now perform these services ourselves, with a relatively small increase in cost, and no longer have the cost of remitting to CACI any payment based on the revenue associated with these services. This improvement was partially offset by relatively small increases in costs relating to an expansion of our support staff, through increased headcount and by re-assigning some existing personnel from our sales organization.
Fiscal 2011 compared to fiscal 2010
Total gross margin decreased in fiscal 2011 as lower product margins outweighed improvements in service and other margins.
Product gross margin was down primarily due to reverse economies of scale, with a lower amount of product revenues available to absorb manufacturing overhead, and also due to slightly higher fixed manufacturing costs. These effects upon product margins were partially offset by 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 in earlier years. Also, product margins benefited by lower inventory reserves compared to the prior fiscal year. Inventory reserve charges for fiscal 2011 were $550,000, whereas in fiscal 2010, such charges, which principally related to our NX5010 product, were $1.9 million.
Service and other gross margin improved due to the termination of the revenue sharing arrangement with our former service partner, CACI, in December 2010. This improvement was partially offset by additional costs relating to an expansion of our support staff, through increased headcount and by re-assigning some existing personnel from our sales organization.
Index
Operating expenses
We expect operating expenses to decrease in fiscal 2013 as the restructuring plan implemented in the fourth quarter of fiscal 2012 takes effect. The goal of the restructuring plan is to reduce operating expenses and preserve capital resources. The anticipated decrease in operating expense will result primarily from headcount reductions. We have reduced our headcount by approximately 90 employees as compared to the beginning of calendar 2012.
Fiscal 2012 compared to fiscal 2011
Total operating expenses were down slightly in fiscal 2012 primarily due to reduced facilities costs following renewal of our headquarters facility lease at more favorable rates, partially offset by additional costs due to an extended duration of the fiscal year by the addition of an extra week in the second fiscal quarter to normalize the fiscal year end date.
Sales and marketing expense was lower due to reductions of $804,000 in payroll-related costs (other than sales commissions), $277,000 in allocated facilities costs, and $174,000 in consulting costs following conversions of certain consultants to employees (though with an offsetting increase in payroll-related costs). These cost savings were partially offset by an increase of $339,000 in sales commissions, as a result of realization of certain individual sales targets, and by an increase of $82,000 in administrative costs, consisting principally of audit and payroll processing fees relating to foreign sales offices.
Research and development expense was lower due to reductions of $513,000 in allocated facilities costs, $134,000 in depreciation expense as many capital assets came to the end of their depreciation lives over the past two years and $57,000 in employment-related costs. These cost decreases were partially offset by increases of $320,000 and $81,000, respectively in consulting costs and engineering related expenses, principally for development activities related to the UX1000 product, released late in the fiscal year.
General and administrative expense was lower as a result of $1.4 million of additional legal fees incurred in fiscal 2011 but not fiscal 2012 for an internal investigation of export-related activities, and also as a result of reductions of $454,000 in compensation-related costs and $226,000 in allocated facilities costs. These cost decreases were partially offset by increases of $654,000 in consulting costs and $491,000 in outside services fees, principally due to changes in the timing of recognition for costs related to audit and tax services.
Restructure and other costs of $1.4 million and $281,000 for fiscal 2012 and fiscal 2011, respectively, related to net charges for employee separation costs related to corporate restructuring activities.
Fiscal 2011 compared to fiscal 2010
Total operating expenses were slightly lower in fiscal 2011 due principally to the effect of cost control measures and reduced facilities costs following the renewal, in the second quarter of fiscal 2011, of our headquarters facility lease at favorable rates. These cost savings were partially offset by legal costs incurred for an internal investigation regarding compliance with U.S. export laws.
Sales and marketing expense was down slightly in fiscal 2011 due to reduced employee compensation costs, which were down $569,000. A principal reason for the difference is that in fiscal 2010 we incurred employee separation costs of $714,000 in connection with the retirement of our former federal sales executive, and had no similar charges in fiscal 2011. Also, sales commissions were lower by $220,000 due to reduced bookings, and costs for consultants and temporary employees were $93,000 lower. Also contributing to the reduction in compensation costs, some technical sales support staff were moved to our service organization following termination of the CACI arrangement.
Offsetting these decreases, stock compensation expense, direct payroll costs and miscellaneous other payroll costs increased by $443,000 principally due to higher average headcount. Other operating costs for sales and marketing also increased by a total of $504,000. Costs for marketing materials and travel and entertainment were higher by a total of $311,000, reflecting product launch and deployment activities for our UX Series product. Costs for products deployed for sales and marketing purposes, such as those provided for use in Microsoft Training Centers, were higher by $167,000. Miscellaneous other costs were higher by $195,000. These cost increases were partially offset by reduced allocations of facilities costs, which were lower by $169,000.
Index
Research and development expense in fiscal 2011 was approximately equal to 2010 expense, although with significant increases and decreases in specific costs. Employee compensation for research and development was higher by $1.3 million, largely due to UX Series development programs, including additional costs for consultants and temporary employees of $785,000. Also, stock compensation expense increased by $429,000 due to the issuance of stock awards tied to new product milestones, and direct payroll costs increased by $65,000, largely due to higher average headcount. These increases were offset by reduced expenditures in the following areas: engineering-related expenses were lower by $566,000, principally because fiscal 2010 results included substantial costs for prototype and expensed material used in development activities; depreciation expense was lower by $266,000, as many of the Company’s capital assets came to the end of their depreciation lives over the past two years; allocations of facilities costs were lower by $507,000; and miscellaneous other costs were higher by $43,000.
General and administrative expense was lower in fiscal 2011. The largest single reason for the difference is that in fiscal 2010 we incurred one-time employee separation costs of $878,000 in connection with the departure of our former Chief Financial Officer and there were no similar charges in fiscal 2011. Other reasons for the decline were: outside consulting costs were lower by $530,000 due principally to lower professional service fees; other payroll-related costs, including stock-based compensation, were lower by $229,000; allocations of facilities costs were lower by $254,000; and miscellaneous other costs that included bad debt, bank fees, and accretion charges for our vacated facility, were lower by $170,000.These decreases were offset by higher legal fees, which increased by $752,000 due principally to costs for an internal investigation of our export-related activities, which was performed by outside counsel.
Restructure and other costs of $281,000 and $17,000 for fiscal 2011 and fiscal 2010, respectively, related to net charges for employee separation costs related to corporate restructuring activities.
Non-operating items
Other income (expense), net, consisted of:
Fiscal 2012 compared to Fiscal 2011
Interest income was lower in fiscal 2012 due to lower average interest earned on investments, and to lower average cash and investment balances. Average cash and investment balances in fiscal 2012 were lower primarily due to the effect of operating losses in fiscal 2012 and 2011.
Interest expense in fiscal 2012 and 2011 was essentially equivalent, primarily because the balance of long-term debt was identical throughout each of the two periods.
Other income (expense), net, was lower in fiscal 2012 due to higher losses on foreign exchange transactions and lower realized gains on available-for-sale securities. Gains and losses on foreign exchange transactions vary with exchange rate fluctuations.
Fiscal 2011 compared to fiscal 2010
Interest income was lower in fiscal 2011 due to lower average interest earned on investments, and to lower average cash and investment balances. Average cash and investment balances in fiscal 2011 were lower primarily due to the effect of operating losses in fiscal 2011 and 2010.
Index
Interest expense was lower in fiscal 2011, due principally to the effect of the retirement of a portion of our outstanding debt through repurchases in fiscal 2010.
Other income and expense was lower in fiscal 2011 due to higher losses on foreign exchange transactions and lower realized gains on available-for-sale securities. In addition, in fiscal 2010 we realized gains upon the retirement of a portion of our outstanding debt through repurchases and did not have such gains in fiscal 2011.
Income tax provision
Income tax provisions were $78,000, $131,000 and $72,000, for fiscal 2012, 2011 and 2010, respectively. All prior periods benefited from a U.S. federal refundable credit as a result of legislation that allowed 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, which extended the period for eligible property additions for another year, through December 31, 2009. The refundable credit ended December 31, 2009. Provisions for income tax are primarily related to our international operations. We incurred an additional one-time tax expense of $46,000 in the third quarter of fiscal 2011 on interest income related to freight/duty refunds received by our United Kingdom subsidiary.
Liquidity and Capital Resources
Historically, our primary sources of liquidity and capital resources have been our cash and investment balances and cash provided by operating activities and debt financing activities.
Cash balances: As of March 30, 2012, cash and cash equivalents, short-term investments and restricted cash were $35.1 million, as compared to $61.4 million as of March 25, 2011. U.S. government and municipal agency investments comprised 58% of the amount outstanding at March 30, 2012.
Cash flow from operating activities:
The increase in net cash used in operating activities in fiscal 2012 resulted principally from the higher net loss in fiscal 2012 and changes in non-cash activities, partially offset by a reduction in cash used as a result of changes in asset and liability balances.
The higher net loss contributed $7.8 million to the increase in cash used in operating activities. Changes in non-cash activities, principally reduced stock compensation expense, contributed an additional $3.2 million. Stock compensation expense was lower in fiscal 2012 primarily because, at the end of fiscal 2011, the Company ended its program of granting restricted stock to offset salary reductions.
These increases in cash used in operating activities were partially offset by the net effect of changes in asset and liability balances in fiscal 2012, which provided a net increase in cash of $2.6 million, compared to fiscal 2011. Accrued liabilities and accounts payable balances continued to decline in FY12, reflecting reduced business activity. However, as the decline in these balances was not as much in fiscal 2012 as in fiscal 2011, the effect of these activities upon cash used was significantly less than in fiscal 2012. Changes in prepaid expense balances provided more cash in fiscal 2012 than in fiscal 2011, due principally to a reduction of the Company’s deposit with Plexus of $1.75 million. These increases in cash provided by operating activities were partially offset by lower collections of accounts receivable, by $3.6 million, in fiscal 2012. Fiscal 2011 collections were higher due to greater revenues realized in fiscal 2010.
The increase in net cash used in operating activities of $3.9 million in fiscal 2011 resulted principally from the higher net loss in fiscal 2011 and reductions in accounts payable balances. Accounts payable balances declined primarily because the Company did not need to make as many inventory purchases in support of sales in fiscal 2011 as it did in fiscal 2010. Increases in cash used in operating activities were partially offset by the effect of higher collections on accounts receivable in fiscal 2011 and a lower accounts receivable balance at fiscal 2011 year-end. The collective effect of other activities upon cash used in operating activities in fiscal 2011, including depreciation, amortization and accretion and stock-based compensation expense, was not significant.
In fiscal 2010, cash used in operating activities was primarily the result of the fiscal 2010 net loss of $17.8 million and lower collections on accounts receivable, partially offset by changes in assets and liability balances, principally prepaid assets and accounts payable.
Cash flow from investing activities:
Net cash provided by investing activities was $30.0 million, $15.2 million, and $4.4 million in fiscal 2012, 2011 and 2010, respectively.
Index
The increase in net cash provided by investing activities in fiscal 2012 compared to fiscal 2011, and in fiscal 2011 compared to fiscal 2010 resulted from the net effect upon cash of purchases, sales and maturities of short-term investments. These activities provided net cash of $30.5 million in fiscal 2012 and $18.4 million in fiscal 2011. We used the cash provided by investing activities in fiscal 2012 and 2011 principally to fund operating activities.
In fiscal 2010, net cash provided by investing activities was a relatively low $4.4 million. Operating activities in fiscal 2010 were principally funded by the cash on hand at the beginning of fiscal 2010.
Cash flow from financing activities:
Net cash used in financing activities was $416,000, $566,000, and $2.4 million in fiscal 2012, 2011 and 2010, respectively.
Financing activities in all years presented included repurchases of common stock from employees to satisfy withholding-tax obligations arising from the vesting of restricted stock awards. In fiscal 2011 and 2010, the effect of these repurchases was partially offset by cash provided by proceeds from exercises of stock options. In addition, fiscal 2010 financing activities included a payment of $1.9 million to repurchase a portion of our outstanding 3¾% convertible senior notes.
Non-cash investing activities: There were no non-cash investing activities in fiscal 2012. We acquired assets under capital lease and through notes payable in fiscal 2011 and 2010 in the amounts of $162,000 and $286,000, respectively.
Summary disclosures about contractual obligations and commercial commitments: The following table provides a summary of our contractual obligations and other commercial commitments as of March 30, 2012:
We have a contract with a third-party technology supplier that calls for payment by us of $2.5 million upon receipt of deliverables meeting certain conditions. We believe it is unlikely these payments will become due or be paid.
We have a long-term income tax liability for uncertain tax positions amounting to $360,000 at March 30, 2012. We cannot currently predict the date of settlement or payment, as the timing of resolution of our liability is highly uncertain.
In the normal course of business, we enter into contractual commitments to purchase services, materials, components, and finished goods from suppliers, mainly our primary contract manufacturer, Plexus. Under our agreement with Plexus, 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. The term of our agreement with Plexus currently runs to December 31, 2012, with automatic renewal for additional one-year terms unless either party gives notice of intent not to renew, and subject to either party’s right to terminate upon six month’s notice.
At March 30, 2012, Plexus held inventory related to our products. Our deposit relating to this inventory was $2.3 million and reserves relating to this deposit were $1.3 million. Both the deposit and the related reserves are included in prepaid expenses and other assets on the consolidated balance sheets. Additional deposits may be required under the terms of the agreement.
Liquidity: 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. However, if the effects of our restructuring commenced in January 2012 and continued in March 2012 are not materially consistent with our expectations, we may encounter cash flow and liquidity issues during that period. We will continue to assess our cash consumption, and our liquidity position. At any time, if we determine that it is necessary, we will evaluate our alternatives and take appropriate steps to address liquidity issues, either by further reducing cash consumption, raising additional capital, or a combination of measures. If additional capital is needed we cannot be assured that it will be available to us and, if we are unable to raise it or raise it on acceptable terms, we may have to delay, reduce the scope of, or eliminate some or all of our research and development programs or other operations, which may include delaying further development of our products; or reduce marketing, customer support or other resources devoted to our products or operations. Any of these developments could harm our business, results of operations, or financial condition.
Index
Off-Balance Sheet Arrangements:
Other than the commitments described above, there are no 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.
Recently Issued Accounting Standards
See Note 1 of our Notes to Consolidated Financial Statements, Description of Business and Summary of Significant Accounting Policies, for recent accounting pronouncements, including the expected dates of adoption and estimated effects on our consolidated financial statements.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about our market risk disclosure involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements.
A portion of our investment portfolio is composed of income securities. These securities are subject to interest rate risk and will fall in value if market interest rates increase. A sensitivity analysis assuming a hypothetical increase or decrease of 10% from levels at March 30, 2012 and March 25, 2011 indicated the fair value of the portfolio would change by approximately $15,000 and $44,000 at March 30, 2012 and March 25, 2011, respectively. At March 30, 2012, the fair value of the short-term investments was $26.2 million compared to $56.9 million at March 25, 2011.
We have foreign currency risks related to our revenues and operating expenses denominated in currencies other than the U.S. dollar, principally the Japanese Yen, the British pound sterling, and the euro. The amounts of future gains or losses from foreign exchange transactions will depend in part on the timing and amount of foreign currency exchange rate movements.
The fair market value of our 3¾% convertible senior notes and 7¼% redeemable convertible subordinated debentures are sensitive to changes in interest rates and to the prices of our common stock into which they can be converted as well as our financial stability. The yield to maturity on the debentures is fixed, therefore the interest expense on the debt does not fluctuate with interest rates. We have estimated the approximate fair value of these securities using recent quotes and trades. The fair value of the trading debt securities was approximately:
Index
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Highlights:
Quarterly financial data (unaudited):
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Network Equipment Technologies, Inc.
Fremont, California
We have audited the accompanying consolidated balance sheets of Network Equipment Technologies, Inc. and subsidiaries (the "Company") as of March 30, 2012 and March 25, 2011, and the related consolidated statements of operations, comprehensive loss, stockholders' equity, and cash flows for each of the three years in the period ended March 30, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15a(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Network Equipment Technologies, Inc. and subsidiaries as of March 30, 2012 and March 25, 2011, and the results of their operations and their cash flows for each of the three years in the period ended March 30, 2012, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/DELOITTE & TOUCHE LLP
San Jose, California
June 14, 2012
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
See accompanying notes to consolidated financial statements
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO 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.
Liquidity: With the exception of fiscal 2008, the Company has incurred net losses since fiscal 1998. The Company believes that existing cash, cash equivalents and short-term investments will be sufficient to fund operations for at least the next twelve months. However, if the effects of the restructuring that the Company commenced in January 2012 and continued in March 2012 are not materially consistent with management’s expectations, the Company may encounter cash flow and liquidity issues during that period, which may require the Company to evaluate alternatives and take appropriate steps to address such issues, either by further reducing cash consumption, raising additional capital, or a combination of measures. If such steps are needed the Company cannot be assured that it will be able either to sufficiently reduce cash consumption without adverse effects on its business or to obtain additional capital on acceptable terms, if at all.
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.
Segments: The Company’s management uses consolidated financial information in determining how to allocate resources and assess performance. For this reason, the Company has determined that it is engaged in a single reportable segment.
Basis of Presentation: The Company’s fiscal year ends on the last Friday in March. In most years, including fiscal 2011 and 2010, the fiscal year is 52 weeks, with each quarter comprised of thirteen weeks, which allows comparability of quarter over quarter results. Fiscal year 2012 included 53 weeks, with the extra week occurring in the three month period ended September 30, 2011.
Revenue Recognition: The Company derives revenue primarily from the sales of hardware, software, services, post-contract support (PCS), and professional services. PCS typically includes unspecified software updates and upgrades on an if-and-when available basis and telephone and internet access to technical support personnel.
In October 2009, the Financial Accounting Standards Board (FASB) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance. In October 2009, the FASB also amended the standards for multiple deliverable revenue arrangements to:
(i)
provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the arrangement consideration should be allocated among its elements;
(ii)
require an entity to allocate the revenue using estimated selling prices (ESP) of the deliverables if there is no vendor specific objective evidence (VSOE) or third party evidence of selling price (TPE); and
(iii)
eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.
This new accounting guidance became applicable to the Company beginning the first quarter of its fiscal 2012. The Company adopted this guidance for transactions that were entered into or materially modified on or after March 26, 2011 using the prospective basis of adoption.
Product revenue is recognized when the Company has a contract with its customer, the product has been shipped as required by the contract and risk of loss has passed to its customer, the price is fixed or determinable, and the collectability of the related receivable is probable. If the customer has a right of acceptance and the Company has not yet obtained acceptance, revenue is deferred until the terms of acceptance are satisfied. When product revenue is deferred, the Company also defers the associated cost of goods until the revenue is recognized. The Company recognizes service revenue upon completion of the service or, for ongoing services such as PCS, ratably over the period of the contract.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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 inventory of NET products. For the Company’s Promina, VX, NX and UX products, NET’s customers generally do not have the right to return the equipment. For the Company’s Tenor 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 new revenue recognition guidance does not generally change the units of accounting for the Company’s revenue transactions. All of the products and services continue to qualify as separate units of accounting. The Company analyzes all of its products, software and services and considers the features and functionalities of the individual elements and the stand-alone sales of those individual components among other factors, to determine which elements are essential or non-essential to the overall functionality of the networking equipment. The Company’s core software (herein after referred to as ‘essential software’) is integrated with hardware and is essential to the functionality of the networking equipment. The Company’s sale of additional software provides increased features and functions, but is not essential to the overall functionality of the networking equipment (herein after referred to as ‘non-essential software’).
For transactions entered into prior to the first quarter of fiscal 2012, the Company recognized revenue based on the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 985-605 (formerly referred to as Statement of Position No. 97-2, Software Revenue Recognition). In accordance with ASC 985-605, the Company utilized the residual method to determine the amount of product revenue to be recognized. Under the residual method, the fair value of the undelivered elements, such as PCS, is deferred and the remaining portion of the arrangement consideration is recognized as product revenue. VSOE of fair value is limited to the price charged when the same element is sold separately. VSOE of fair value is established for PCS and professional services based on the volume and pricing of the stand-alone sales within a narrow range. The fair value of the post-contractual support is recognized on a straight-line basis over the term of the related support period, which is typically one month to three years.
For transactions entered into or materially modified on or after the beginning of the first quarter of fiscal 2012, the total arrangement fees were allocated to all the deliverables based on their respective relative selling prices. The relative selling price is determined using VSOE when available. When VSOE cannot be established, the Company attempts to determine the TPE for the deliverables. TPE is determined based on competitor prices for similar deliverables when sold separately by the competitors. Generally the Company’s product offerings differ from those of its competitors and comparable pricing of its competitors is often not available. Therefore, the Company is typically not able to determine TPE. When the Company is unable to establish selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement fees. The ESP for a deliverable is determined as the price at which the Company would transact if the products or services were sold on a stand-alone basis.
The Company has been able to establish VSOE for its PCS and professional services based on the volume and the pricing of the stand-alone sales for these services within a narrow range.
The Company has determined the ESP of its products and services for which VSOE has not been established based on an analysis of (i) the list price, which represents a component of the Company’s current go-to market strategy, as established by senior management taking into consideration factors such as geography and the competitive and economic environment and (ii) an analysis of the historical pricing with respect to both the Company’s bundled and stand-alone sales of each product or service.
The Company’s multiple element arrangements may include non-essential software deliverables that are subject to the industry specific software revenue recognition guidance. The revenue for these multiple element arrangements is allocated to the non-essential software deliverables and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the new revenue accounting guidance. As the Company has not been able to obtain VSOE for all of the non-essential software deliverables in the arrangement, revenue allocated to such non-essential software elements is recognized using the residual method in accordance with industry specific software revenue recognition guidance as the Company was able to obtain VSOE for the undelivered elements bundled with such non-essential software elements. Under the residual method, the amount of revenue recognized for the delivered non-essential software elements equaled the total allocated consideration less the VSOE of any undelivered elements bundled with such non-essential software elements.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The change from the residual to the relative selling price method did not have a material impact on the allocation of revenue to the arrangement deliverables, nor did the Company change its assessment of the deliverables contained within its revenue arrangements. The adoption of the new revenue accounting guidance was not material to the Company’s financial results for the fiscal year ended March 30, 2012.
Financial Statement Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to 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 management estimates and assumptions 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 intangibles, inventories, warranty costs, the valuation allowance on deferred tax assets, certain reserves and accruals, estimated lives of depreciable and amortizable assets, and assumptions related to stock-based compensation. Actual results could differ from those estimates.
Cash and Cash Equivalents: Cash and cash equivalents include highly liquid investments with original maturities of three months or less at the time of acquisition. The Company, at times, maintains cash balances in excess of the federally insured limit of $250,000.
Short-term Investments: Short-term investments are primarily composed of highly liquid investments with original maturities of greater than three months at the time of acquisition. The Company classifies its short-term cash investments as available-for-sale securities. The carrying value of such securities is carried at fair market value with unrealized gains and losses being excluded from earnings and reported as a separate component of stockholders’ equity. Realized gains and losses on the sale or maturity of short-term investments are determined on the basis of specific identification.
Restricted Cash: Restricted cash consists of cash collateral related to short-term letters of credit required to be maintained for leases in the United States.
Allowance for Sales Returns: A reserve for sales returns is established for primarily reseller and distributor customers, based on actual historical product returns.
Credit Risk and Allowance for Doubtful Accounts: The Company’s credit evaluation process and the reasonably short collection terms help mitigate credit risk. The Company typically does not require collateral or other security to support accounts receivable. The Company performs ongoing credit evaluations of its customers’ financial condition and limits the amount of credit extended when deemed necessary. The Company maintains reserves for known recourse obligations and estimated bad debts. The allowance for doubtful accounts receivable is based on the assessment of the collectability of specific customer accounts and the aging of accounts receivable. Credit losses have historically been within the Company’s expectations and the established allowances for doubtful accounts receivable.
Inventories: Inventories are stated at the lower of cost (first-in, first-out) or market and include material, labor and manufacturing overhead costs.
Property and Equipment: Property and equipment are stated at cost. Depreciation is computed using the straight-line method over estimated useful lives of generally three to ten years. Leasehold improvements are amortized over the shorter of the respective lease terms or estimated useful lives. Depreciation and amortization of property plant and equipment was $1.9 million, $2.3 million and $3.0 million in fiscal 2012, 2011 and 2010, respectively.
Long-lived asset: The Company reviews long-lived assets, including intangible assets with finite lives, property and equipment, and other assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Conditions that would necessitate an impairment assessment include a significant decline in the market price of an asset or asset group, a significant adverse change in the extent or manner in which an asset or asset group is being used, the loss of legal ownership or title to the asset, significant negative industry or economic trends or the presence of other factors that would indicate that the carrying amount of an asset or asset group is not recoverable. We consider a long-lived asset to be impaired if the estimated undiscounted future cash flows resulting from the use of the asset and its eventual disposition are not sufficient to recover the carrying value of the asset. If we deem an asset to be impaired, the amount of the impairment loss represents the excess of the asset’s carrying value compared to its estimated fair value.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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.
Foreign Currency: The functional currency for the Company’s foreign subsidiaries is the local currency. Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at the rates of exchange in effect at the end of the period. Revenue and expenses are translated into dollars at the average exchange rate during the period. Gains and losses from foreign currency translation are included in a separate account in stockholders’ equity in the consolidated balance sheets.
Foreign exchange transaction gains and losses, substantially all of which relate to intercompany activity between the Company and its foreign subsidiaries, amounted to losses of $420,000, $180,000 and $45,000 in 2012, 2011 and 2010, respectively. These losses are included in other income (expense) in the accompanying consolidated statements of operations.
Loss Contingencies: The Company is subject to the possibility of various loss contingencies arising in the ordinary course of business. Management considers the likelihood of loss related to an asset, or the incurrence of a liability, as well as its ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. The Company records a charge equal to the minimum estimated liability or a loss contingency only when both of the following conditions are met: (i) information available prior to issuance of the consolidated financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and (ii) the range of loss can be reasonably estimated. The Company regularly evaluates current information available to determine whether such accruals should be adjusted and whether new accruals are required.
The Company provides disclosure when it is reasonably possible that a loss will be incurred or when it is reasonably possible that the amount of a loss will exceed the recorded provision. In such cases, management assesses whether a reasonable estimate of the loss or range of the loss can be made. If the loss or range of loss can be estimated, the Company does so. If management concludes the loss or range of loss cannot be estimated, the Company discloses its conclusion in that regard.
From time to time, the Company is involved in disputes, litigation, and other legal actions. The Company is aggressively defending its current litigation matters. However, there are many uncertainties associated with any litigation and these actions or other third-party claims against the Company may cause the Company to incur costly litigation and/or substantial settlement charges. If any of those events were to occur, the Company’s business, financial condition, results of operations, and cash flows could be adversely affected. The actual liability in any such matters may be materially different from the Company’s estimates, which could result in the need to adjust the liability and record additional expenses.
Stock-based Compensation: The Company recognizes stock-based compensation expense for all share-based payment awards including employee stock options and restricted stock awards, in accordance with FASB ASC Topic 718, Compensation - Stock Compensation. Stock-based compensation expense for expected-to-vest stock-based awards is valued under the single-option approach and amortized on a straight-line basis, net of estimated forfeitures. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s consolidated statements of operations for all periods presented.
The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. The fair value is amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The Company’s computation of expected volatility is based on historical volatility commensurate with the expected term of the options. The risk-free interest rate used in the Black-Scholes option-pricing formula is based on the implied yield currently available on U.S. Treasury securities with an equivalent remaining term commensurate with the expected term of the options. The expected dividend assumption is based on the Company’s current expectations about future dividends and the Company does not expect to pay out cash dividends in the foreseeable future. The Company estimated the expected term of options granted in fiscal 2012, 2011 and 2010 using vesting periods of awards and historical data such as past experience and post vesting cancellations. The Company believes these calculations provide reasonable estimates of expected life for stock-based awards to employees.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Comprehensive Loss -ASC 220 - Reporting Comprehensive Income establishes standards for the reporting and displaying of comprehensive income (loss) and its components. Comprehensive loss includes foreign currency translation adjustments, gross unrealized holding gains (losses) on available-for-sale securities, and reclassification adjustments for gains included in net loss.
Derivatives: The Company does not use derivative financial instruments for speculative or trading purposes. In fiscal 2012, 2011 and 2010, the Company entered 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. At March 30, 2012, there were no foreign exchange forward contracts outstanding.
Recently Issued Accounting Standards: In June 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends ASC 220 to allow an entity the option to present income and comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. In December 2011, the FASB issued guidance which indefinitely defers the guidance related to the presentation of reclassification adjustments. As the Company has historically presented a separate statement of comprehensive income (loss), we do not anticipate the adoption of this ASU will have any effect upon our financial statement presentation.
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs . This ASU represents the converged guidance of the FASB and the International Accounting Standards Board (the Boards) on fair value measurement. The Company adopted this new guidance, on a prospective basis, on December 31, 2011, the beginning of the fourth quarter of the Company’s fiscal 2012. The adoption of ASU 2011-04 did not have a material effect upon the Company’s consolidated financial statements for the year ended March 30, 2012.
In January 2010, the FASB issued new accounting guidance to amend and clarify existing guidance related to fair value measurements and disclosures: ASU No. 2010-06 Improving Disclosures about Fair Value Measurements. This guidance requires entities to separately present purchases, sales, issuances, and settlements in their reconciliation of Level 3 fair value measurements (i.e., to present such items on a gross basis rather than on a net basis), and clarifies existing disclosure requirements regarding the level of disaggregation and the inputs and valuation techniques used to measure fair value for measurements that fall within either Level 2 or Level 3 of the fair value hierarchy. The Company adopted the provisions of this guidance effective March 27, 2010, except for the requirement to disclose purchases, sales, issuances, and settlements related to Level 3 measurements, which the Company adopted on March 26, 2011, the beginning of the Company’s fiscal 2012. The adoption of ASU 2010-06 did not have a material effect upon the Company’s consolidated financial statements for the year ended March 30, 2012.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Note 2. Financial Instruments
Short-term investments at March 30, 2012 and March 25, 2011 consisted of the following:
The maturities of short-term investments at March 30, 2012 are as follows:
Unrealized gain positions for short-term investments held twelve months or more were $21,000 and $187,000 at March 30, 2012 and March 25, 2011, respectively.
The following table summarizes the financial assets and liabilities of the Company measured at fair value on a recurring basis:
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(1)
Included in short-term investments on the Company’s consolidated balance sheet.
(2)
Included in accounts receivable on the Company’s consolidated balance sheet.
(3)
Included in accrued liabilities on the Company’s 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 inputs other than quoted prices included within Level 1, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs other than quoted prices that are observable or are derived principally from, or corroborated by, observable market data by correlation or other means.
Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
The valuation techniques used to measure the fair value of financial instruments, all of which have counterparties with high credit ratings, were valued based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data.
Investments are classified within Level 1 if quoted prices are available in active markets.
Items are classified in Level 2 if the investments are valued using quoted prices for identical assets in markets that are not active, using quoted prices for similar assets in an active market, or using model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets.
The Company did not hold financial assets or liabilities which were recorded at fair value using inputs in the Level 3 category as of March 30, 2012 and March 25, 2011.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Derivative financial instruments are limited to foreign exchange contracts which the Company enters into to minimize 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 these foreign exchange contracts, which are not designated as hedging instruments, are included in other income and expense, net, and were not material for any period presented. As of March 30, 2012, the Company had no outstanding foreign exchange contracts.
Note 3. Inventories
Inventories consisted of the following:
Certain inventories, not expected to be consumed within the next 12 months, are included in the consolidated balance sheet as non-current other assets. These inventories consist of both purchased components and finished goods, and were $622,000 and $2.5 million, respectively, at March 30, 2012 and March 25, 2011.
Subsequent to the issuance of the fiscal 2011 consolidated financial statements, management determined that certain inventories, not expected to be consumed within the next 12 months were reflected in the consolidated balance sheet as current assets within inventories. These inventories should have been reflected as noncurrent and included within other assets. Management has corrected this error by reclassifying $1.7 million of inventories as follows:
●
Inventories for fiscal year 2011 originally reported of $4.7 million were corrected to $3.0 million.
●
Other assets for fiscal year 2011 originally reported of $4.3 million were corrected to $6.0 million.
The corrections did not affect the total assets previously reported. In addition, management has corrected the following:
●
Long term inventory for fiscal year 2011 previously disclosed above and in footnote 4 has been increased from $805,000 to $2.5 million.
●
Change in inventories in the condensed consolidated statement of cash flows for the year ended March 25, 2011 originally reported of $(283,000) was corrected to $1.4 million.
●
Change in prepaid expenses and other assets in the condensed consolidated statement of cash flows for the year ended March 25, 2011 originally reported of $2.8 million was corrected to $1.2 million.
The foregoing corrections did not affect the net cash used in operating activities and are not considered material by management.
Under the Company’s agreement with its primary contract manufacturer, Plexus Corp. (Plexus), 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. The term of our agreement with Plexus currently runs to December 31, 2012, with automatic renewal for additional one-year terms unless either party gives notice of intent not to renew, and subject to either party’s right to terminate upon six months notice.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
At March 30, 2012, the Company’s deposit on inventory held by Plexus was $2.3 million, of which $1.3 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 consolidated balance sheets.
The Company regularly evaluates its inventory, including inventory held by Plexus and the amount on deposit with Plexus as well as inventory classified non-current assets. As a result of these evaluations, the Company recorded charges of $2.1 million, $550,000, and $1.9 million, respectively, to cost of revenue in fiscal 2012, 2011 and 2010.
Note 4. Other Assets and Accrued Liabilities
Other assets at March 30, 2012 and March 25, 2011 were as follows:
Accrued liabilities at March 30, 2012 and March 25, 2011 were as follows:
See also Note 6 for activity in the liability for restructuring.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Note 5. Warranty Accruals
The warranty accrual, which is included in accrued liabilities in the accompanying consolidated balance sheets, was $232,000 at March 30, 2012, as shown in the table below. Components of the warranty accrual and changes in accrued amounts related to the warranty accrual during fiscal 2010, 2011 and 2012 were as follows:
(1)
Adjustments resulted from changes in warranty cost estimates, relating primarily to hourly costs of labor to repair products and frequency of warranty claims.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Note 6. Restructure and Other
Restructure and other costs of $1.4 million in fiscal 2012, $281,000 in fiscal 2011 and $17,000 in fiscal 2010 relate to charges for employee separation costs. In the fourth quarter of fiscal 2012, the Company announced implementation of a restructuring plan to reduce operating expenses, and preserve capital resources. The restructure and other cost of $1.4 million recognized in fiscal 2012 represents the total expected cost of the fiscal 2012 restructuring plan and consists totally of costs relating to severance and termination benefits. The Company anticipates payments of amounts relating to the fiscal 2012 restructuring will be substantially completed by the end of the first quarter of fiscal 2013.
The liability for restructuring was $837,000 at March 30, 2012, as shown in the table below. Components of accrued restructure costs and changes in accrued amounts related to these restructuring programs during fiscal 2010, 2011, and 2012 are as follows:
(1)
Consists primarily of accretion and adjustments to 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 consolidated statement of operations. Adjustments to accretion were related to the Company’s revision of its estimate of the remaining liability for lease and other exit costs.
The balance at March 26, 2010 includes $822,000 classified as other long-term liabilities related to lease and other exit costs for a vacated facility, net of an estimated amount of sublease income. Liabilities for restructuring at March 25, 2011 and March 30, 2012 were classified as current liabilities.
Note 7. Income Taxes
Loss before income taxes and income tax provision consist of the following for fiscal 2012, 2011 and 2010:
The Company’s tax expense for fiscal 2012, 2011 and 2010 primarily related to international operations.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The income tax expense reconciles to the amount computed by applying the statutory United States federal rate of 35% to income (loss) before income taxes as follows:
Deferred tax assets are comprised of the following at March 30, 2012 and March 25, 2011:
The valuation allowance increased by $14.2 million, $10.6 million and $6.5 million in fiscal 2012, 2011 and 2010, respectively. The Company's operating loss carryforwards and credits, which have been offset by the valuation allowance, include $4.7 million of deferred tax benefits associated with stock -based compensation, which will be credited to additional-paid-in-capital when realized. The Company has incurred tax losses in the last several fiscal years and, at March 30, 2012, has approximately $230.3 million of federal net operating loss carryforwards and $171.4 million of state net operating loss carryforwards available, expiring in the years 2013 through 2032. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of its deferred tax assets will not be realized. FASB ASC Topic 740, Income Taxes, provides for the recognition of deferred tax assets if realization of such assets is more likely than not to occur. Based upon the weight of available evidence, which includes the Company’s historical operating performance and reported cumulative net losses, the Company provided a full valuation allowance against its United States and most foreign net deferred tax assets. There is no valuation allowance against the Company’s United Kingdom deferred tax assets. The Company reassesses the need for its valuation allowance on a quarterly basis.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As of March 30, 2012, the Company has available federal research and development tax credit carryforwards of approximately $5.6 million expiring in the years 2013 through 2032 and alternative minimum tax credit carryforwards of approximately $2.5 million available indefinitely. At March 30, 2012, state research and development tax credit carryforwards of approximately $15.3 million are also available indefinitely. The Company considers all undistributed earnings of its foreign subsidiaries to be permanently invested in foreign operations. Accordingly, no deferred tax assets or liabilities have been established in this regard.
Current federal and state tax laws include provisions that could limit the annual use of our net operating loss carryforwards in the event of certain defined changes in stock ownership. The Company's issuance of common and preferred stock could result in such a change. Accordingly, the annual use of net operating loss carryforwards may be limited by these provisions, and this limitation may result in the loss of carryforward benefits to the extent the above-limit portion expires before it can be used. The Company has determined the extent of the limitation at March 30, 2012, and the losses reflected in the deferred tax assets will not be subject to limitation.
A reconciliation of the Company's changes in uncertain tax position to March 30, 2012, March 25, 2011 and March 26, 2010 is as follows:
The amount of tax benefits that would, if recognized, affect the effective tax rate at March 30, 2012 was $280,000, as the Company maintains a full valuation allowance against the remaining uncertain tax benefits. Interest and penalties of $9,000, $30,000 and $2,000, respectively, for fiscal 2012, 2011 and 2010 related to income tax matters are recorded in income tax expense. At March 30, 2012, March 25, 2011 and March 26, 2010, $79,000, $148,000 and $118,000, respectively, was accrued for interest and penalties related to uncertain tax benefits.
As of March 30, 2012, tax years from 1998 in the U.S. and 2006 in the Company's primary foreign jurisdictions remain open for examination. Although the timing of resolution and closure of audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next twelve months.
Note 8. Commitments and Contingencies
3¾% Convertible Senior Notes: In December 2007, the Company issued $85.0 million of 3¾% convertible senior notes due December 15, 2014, in a private placement of which $10.5 million remained outstanding at March 30, 2012. 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 publicly traded (meaning, traded on a national securities exchange or quoted on the NASDAQ Global Market or NASDAQ Capital Market or traded on an established automated over-the-counter trading market in the United States), 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. With regards to the Company’s common stock being publicly traded, the common stock is currently listed on The NASDAQ Global Market and the Company is currently in compliance with NASDAQ’s continued listing standards. On March 22, 2012, the Company received a deficiency letter from NASDAQ notifying the Company that it was failing to meet The NASDAQ Global Market’s listing rules requirement for listed securities to maintain a minimum bid price of $1.00 per share, based upon the closing bid price of the Company’s common stock for the 30 consecutive business days prior to the date of the letter. On April 10, 2012, the Company received written notification from NASDAQ that it had regained compliance with the bid price requirement, based upon the Company’s common stock remaining above $1.00 per share for the period from March 23, 2012 to April 9, 2012. The matter is now closed, however the Company remains subject to NASDAQ’s continued listing standards, including the bid price requirement.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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 2010, 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.
Interest expense relating to the 3¾% Convertible Senior Notes was $394,000, $394,000 and $482,000 in fiscal 2012, 2011 and 2010, respectively, and consisted solely of contractual coupon interest.
7¼% Redeemable Convertible Subordinated Debentures: In May 1989, the Company issued $75.0 million of 7¼% redeemable convertible subordinated debentures due May 15, 2014, of which $23.7 million remained outstanding at March 30, 2012. 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 debentures 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.
Interest expense relating to the 7¼% Redeemable Convertible Subordinated Debentures was $1.7 million, $1.7 million, and $1.7 million in fiscal 2012, 2011 and 2010, respectively, and consisted solely of contractual coupon interest.
Operating Leases: The Company leases its facilities under operating leases. These leases expire at various dates through fiscal 2017. The Company’s headquarters facility lease expires in fiscal 2017. The minimum future lease commitments under these leases as of March 30, 2012, were as follows:
Rental expense under operating leases was $2.5 million, $2.6 million and $2.9 million for fiscal 2012, 2011 and 2010, respectively.
Equipment Financing: In fiscal 2011, the Company acquired certain office equipment through two agreements classified as capital leases. The cost of equipment financed by capital leases was $162,000. The terms of the capital lease agreements range from three to five years. One of the capital lease agreements includes a bargain purchase option which the Company may exercise at the end of the lease term. The equipment financed by the capital leases is included in the consolidated balance sheets as property and equipment, net.
In 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 consolidated balance sheets as property and equipment, net.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Amortization of assets under capital lease is included in depreciation expense. Accumulated amortization of assets under capital lease was $188,000, $81,000 and $13,000 at March 30, 2012, March 25, 2011 and March 26, 2010, respectively.
The minimum future lease commitments under capital leases as of March 30, 2012, were as follows:
License and Development Agreement: The Company is a party to a license and development agreement with a third-party technology supplier, under which the Company acquired a license to manufacture and distribute the supplier’s high-speed networking platform. The Company agreed to pay an additional $5.0 million in four equal installments to the supplier for the advanced platform and an extended exclusive right to market. The first two installments were paid in fiscal 2008 and the remaining two will be due at separate future dates dependent upon the supplier’s delivery of future enhancements of the advanced platform. The Company believes it is unlikely the remaining two installments will become due or be paid.
Contingencies: In the normal course of business, the Company enters into contractual commitments to purchase services, materials, components, and finished goods from suppliers, mainly its primary contract manufacturer, Plexus. Under the agreement with Plexus, the Company may incur certain liabilities, as described in Note 3.
Product Warranty: See Note 5.
Restructure: See Note 6.
Litigation: See Note 16.
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.
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, which the Company began issuing in fiscal 2011, 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.
For both RSAs and RSUs, upon release of restrictions, 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 withholding tax obligations were based upon the fair market value of the Company’s common stock on the vesting dates. The Company repurchased shares from employees in fiscal 2012, 2011 and 2010 as follows.
Index
NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Stock Compensation Expense: The following table shows total stock-based compensation expense included in the Consolidated Statements of Operations:
There was no stock-based compensation cost capitalized as part of inventory in fiscal 2012, 2011 or 2010.
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 additional 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.
The fair value of each stock option award is measured, at the date of grant, using a Black-Scholes option pricing model. The weighted average fair value of the Company’s stock option awards granted to employees was $0.83, $2.73 and $3.21, respectively, for fiscal 2012, 2011, and 2010, and was estimated using the following weighted-average assumptions:
At March 30, 2012, the total compensation cost related to unvested stock-based awards not yet recognized, net of estimated forfeitures, was approximately $3.4 million. The weighted-average period during which the cost will be amortized is approximately 1.3 years. The cost to be amortized will be adjusted for subsequent changes in estimated forfeiture rates.
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NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Stock Options and Awards Activity:
Stock option activity in the Company’s employee stock plans is summarized below:
Intrinsic value is calculated as the difference between the market value of our common stock as of March 30, 2012 and the exercise price of the option. The aggregate intrinsic value of options outstanding and options vested and expected to vest includes options with an exercise price below $1.07, the closing price of our common stock on March 30, 2012, as reported by the NASDAQ Global Market.
Stock award activity in the Company’s employee stock plans is summarized below:
The total fair value of RSAs and RSUs vested was $1.5 million, $3.2 million and $2.9 million for fiscal 2012, 2011 and 2010, respectively.
Note 10. Capital Stock
Stock Repurchase Plan: In fiscal 2008, the Board of Directors approved a stock repurchase plan, for a period of up to twenty-four months. In fiscal 2009 the Company repurchased 258,000 shares under the 2008 program at an average price of $3.90 per share for a total price of $1.0 million. The Company did not repurchase any shares under the 2008 program in fiscal 2010 and the stock repurchase plan expired in the fourth quarter of fiscal 2010. In addition, the Company repurchased 128,000, 296,000 and 267,000 shares of common stock from employees in fiscal 2012, fiscal 2011 and fiscal 2010, respectively, to satisfy withholding-tax obligations arising from the vesting of restricted stock awards. See Note 9.
Preferred Stock: The Company has authorized 5,000,000 shares of $0.01 par value preferred stock. This stock, if issued, will carry liquidation preferences and other rights, as determined by the Board of Directors. As of March 30, 2012, no preferred shares were outstanding.
Reserved Stock: As of March 30, 2012, the Company had reserved shares of its common stock for the following purposes:
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NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Note 11. 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:
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, which totaled 178,000, 206,000 and 291,000, respectively, for fiscal 2012, 2011 and 2010, were excluded from the computations of diluted net loss per share as the effect of including those shares would be anti-dilutive and therefore reduce the loss per share.
At March 30, 2012, there were 770,373 shares of common stock issuable upon conversion of convertible senior notes and 752,508 shares of common stock issuable upon conversion of redeemable convertible subordinated debentures. These shares and the related effect of the accrued interest on the convertible senior notes and the debentures are excluded from the calculation of diluted net loss per share for each period presented, as their inclusion would be anti-dilutive.
Note 12. Significant Customers
In fiscal 2012 and in fiscal 2011, no single customer accounted for more than 10% of the Company’s revenue. In fiscal 2010, General Dynamics Corporation accounted for 22.7% of the Company’s revenue. Excluding aggregate orders from a variety of government agencies, no other single customer accounted for more than 10% percent of the Company’s revenue in fiscal 2012, 2011, or 2010.
Sales to the government sector represented 50.2%, 71.1% and 78.6% of the Company’s revenue in fiscal 2012, 2011, and 2010, respectively.
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NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Note 13. Segment Information
The Company operates in one reportable segment: the design, development, manufacture and sale of voice and data telecommunications equipment for multi-service networks and associated services used by government organizations, enterprises, and carriers worldwide. The following table presents revenue and long-lived assets by geographic territory for fiscal 2012, 2011 and 2010:
In fiscal 2012, 2011, and 2010, Promina products accounted for 24.9%, 32.5% and 36.4% of product revenue, respectively. In fiscal 2012, 2011, and fiscal 2010, Tenor products accounted for 24.4%, 18.6% and 16.6% of product revenue, respectively. In fiscal 2012, 2011 and 2010, NX Series products accounted for 7.9%, 8.6% and 21.9%, respectively, of product revenue. In fiscal 2012, 2011, and 2010, the VX Series and predecessor products accounted for 23.2%. 35.3% and 22.3% of product revenue, respectively. The UX series products, which were introduced in the third quarter of fiscal 2011, accounted for 18.7% of product revenue in fiscal 2012. All other products accounted for less than 10% of product revenue, individually and in the aggregate, for all years presented.
Note 14. Employee Benefit Plan
The Company has a 401(k) tax-deferred savings plan, whereby eligible employees may contribute a percentage of their eligible compensation. Company contributions are discretionary; including administrative fees, Company expense was $47,000, $31,000 and $45,000 for fiscal 2012, 2011 and 2010, respectively.
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NETWORK EQUIPMENT TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Note 15. Financial Instruments Fair Value Disclosure
The estimated fair values of the Company’s financial instruments at March 30, 2012 and March 25, 2011 were as follows:
The following methods and assumptions were used in estimating the fair values of financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance sheets for cash and cash equivalents approximate their estimated fair values due to their short maturities.
Short-term Investments: Fair values are based on quoted market prices and observable prices that are based on inputs not quoted on active markets, but corroborated by market data. See Note 2.
Restricted Cash: The carrying value approximates fair value.
Accrued Liabilities: The carrying value approximates fair value.
Convertible Debt: The Company has estimated the approximate fair value of these securities using the quoted market price or trade closest to March 30, 2012. Covertible debt was valued based on Level 2 inputs within the fair value hierarchy. See Note 2.
Foreign exchange contracts: The Company’s foreign exchange forward contracts require an exchange of foreign currencies to U.S. dollars or vice versa, and generally mature in one month or less. As of March 30, 2012, the Company had no outstanding foreign exchange contracts. As of March 25, 2011, the Company had outstanding foreign exchange forward contracts with an aggregate notional amount of $5.9 million, which had a remaining maturity less than one month. The amounts recorded on the consolidated balance sheets for foreign exchange contracts are not material.
Note 16. Litigation
A subsidiary of the Company, Quintum Technologies, LLC (Quintum), is party, by interpleader, to three related lawsuits in Greece filed by Lexis SA, a former distributor of Quintum products in Greece. The initial interpleader lawsuit was filed October 26, 2006, at the Multimember First Instance Court of Athens. At hearings in January and February 2012, the underlying lawsuits were cancelled due to the fact that the originating plaintiffs waived their rights against Lexis prior to the hearing. However, Lexis has not yet formally waived its rights against Quintum, and so hearings are still on calendar on the matter between Lexis and Quintum, now scheduled for January 2015. By way of background, the lawsuits allege that a set of hardware and software products acquired by Lexis for a customer failed to perform as a system. The products include Quintum’s hardware product and a software product by another vendor. The damages sought include a refund of amounts paid for the purchase of the hardware and software, totaling approximately $98,000, compensation for real and moral damages, totaling approximately $4.4 million, and monetary damages totaling approximately $3.6 million for non delivery of services that were to be delivered through the system. The Company has not accrued any amounts related to the claim, as it believes that a negative outcome is not probable.
In addition to the above, the Company is involved in various legal proceedings from time to time in the normal course of its business. The company believes that an unfavorable outcome related to such legal proceedings is neither probable nor estimable.
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ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
(a) Conclusions Regarding the Effectiveness of Disclosure 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 March 30, 2012.
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.
(b) Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the U.S. However, all internal control systems, no matter how well conceived and implemented, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of March 30, 2012.
(c) Changes in Internal Control over Financial Reporting
No changes in our internal control over financial reporting occurred during the quarter ended March 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
Not applicable.
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PART III
Certain information required by Part III is omitted from this Form 10-K because NET will file its definitive proxy statement (“Proxy Statement”) pursuant to Regulation 14A within 120 days after the end of its fiscal year covered by this Report, and certain information included in the Proxy Statement is incorporated by reference into this Part III.
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information requested by Items 401, 405, 406 and 407(c)(3), (d)(4) and (d)(5) of Regulation S-K is incorporated herein by reference to the Proxy Statement. Pursuant to Item 401(b) of Regulation S-K, information about our executive officers is reported under the caption “Executive Officers” in Part I of this report.
Code of Ethics
Our Code of Business Conduct, which covers all directors and employees (including the Chief Executive Officer, Chief Financial Officer and Controller), meets the requirements of the SEC Rules promulgated under Section 406 of the Sarbanes-Oxley Act of 2002 for a code of ethics. The Code of Business Conduct is available free of charge on our Internet website located at www.net.com. In addition, any stockholder who wishes to obtain a printed copy of the Code of Business Conduct should write to: Investor Relations, NET, 6900 Paseo Padre Parkway, Fremont, California 94555-3660. Since adoption of the Code of Business Conduct, our Board has not granted a waiver of any of its provisions for any director or executive officer. Any future waivers or amendments will be disclosed on our Internet website.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information requested by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K is incorporated herein by reference to the Proxy Statement.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information requested by Item 403 of Regulation S-K is incorporated herein by reference to the Proxy Statement.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information requested by Items 404 and 407(a) of Regulation S-K is incorporated herein by reference to the Proxy Statement.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information requested by Item 9(e) of Schedule 14A with respect to the fees and services related to our independent registered public accounting firm and the disclosure of the Audit Committee’s pre-approval policies and procedures is incorporated herein by reference to the Proxy Statement.
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PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)
1. Index to Consolidated Financial Statements
2. Index to Consolidated Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not required, are not applicable, or the information is included in the consolidated financial statements or notes thereto.
Separate financial statements of the Registrant are omitted because the Registrant is primarily an operating company and all subsidiaries included in the consolidated financial statements filed, in the aggregate, do not have a minority equity interest and/or long-term indebtedness to any person outside the consolidated group in an amount which together exceeds 5% of total consolidated assets at March 30, 2012.
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3. Exhibits
Index to Exhibit
*
Compensation plans or arrangements in which directors and executive officers are eligible to participate.
**
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
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NETWORK EQUIPMENT TECHNOLOGIES, INC.
SCHEDULE II
Valuation and Qualifying Accounts
(In thousands)
(1) Amount represents additions or deductions to accounts receivable allowances representing sales return reserves that were charged or credited primarily to revenue.