UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 26, 1999
-----------------
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period ended _________________ or
Commission File Number 0-15323
NETWORK EQUIPMENT TECHNOLOGIES, INC.
------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 94-2904044
- ---------------------------- ---------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification Number)
organization)
6500 Paseo Padre Parkway
Fremont, CA 94555
(510) 713-7300
--------------
(Address, including zip code, and telephone number
including area code, of registrant's
principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
The number of shares outstanding of the registrant's Common Stock, $.01
par value, on December 26, 1999 was 21,442,266.
================================================================================
This document consists of 26 pages of which this is page 1.
<PAGE>
NETWORK EQUIPMENT TECHNOLOGIES, INC.
INDEX
<TABLE>
<CAPTION>
Page
Number
------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Condensed Consolidated Balance Sheets -
December 26, 1999 and March 31, 1999 3
Condensed Consolidated Statements of Operations - Quarter and
Nine months ended December 26, 1999 and December 27, 1998 4
Condensed Consolidated Statements of Comprehensive Income (Loss)
- Quarter and Nine months ended December 26, 1999 and December
27, 1998 5
Condensed Consolidated Statements of Cash Flows -
Nine months ended December 26, 1999 and December 27, 1998 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
PART II OTHER INFORMATION
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
</TABLE>
2.
<PAGE>
NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Balance Sheets
(in thousands - unaudited)
<TABLE>
<CAPTION>
Dec. 26, March 31,
1999 1999 (1)
--------- ---------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents,
$14,351 restricted balance at December 26 $ 29,340 $ 13,720
Temporary cash investments 110,515 140,843
Accounts receivable,
net of allowances of $4,304 at Dec. 26 and $3,375 at March 31 41,448 46,381
Inventories 16,297 19,193
Deferred income taxes -- 5,510
Prepaid expenses and other assets 7,991 6,834
--------- ---------
Total current assets 205,591 232,481
Property and equipment, net 46,046 55,877
Software production costs, net 5,585 6,129
Deferred income taxes -- 9,053
Goodwill and other intangibles 16,021 --
Other assets 10,978 9,572
--------- ---------
$ 284,221 $ 313,112
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 10,571 $ 11,755
Accrued liabilities 47,111 43,638
--------- ---------
Total current liabilities 57,682 55,393
7-1/4% convertible subordinated debentures 24,706 24,706
Stockholders' equity:
Preferred stock, $.01 par value
Authorized: 5,000,000 shares
Outstanding: none -- --
Common stock, $.01 par value
Authorized: 50,000,000 shares
Outstanding: 21,442,000 shares at December 26
and 21,509,000 shares at March 31 214 215
Additional paid-in capital 177,666 180,596
Treasury stock (6,505) (4,853)
Accumulative other comprehensive income (loss) (1,236) 5,921
Retained earnings 31,694 51,134
--------- ---------
Total stockholders' equity 201,833 233,013
--------- ---------
$ 284,221 $ 313,112
========= =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements
(1) Derived from audited consolidated financial statements
3.
<PAGE>
NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts - unaudited)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
------------- -----------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Product revenue $ 24,539 $ 39,981 $ 93,613 $ 132,456
Service and other revenue 26,703 25,933 84,972 80,238
--------- --------- --------- ---------
Total revenue 51,242 65,914 178,585 212,694
--------- --------- --------- ---------
Cost of sales:
Cost of product revenue 11,345 15,031 39,692 50,929
Cost of service and other revenue 17,188 16,873 55,811 50,250
--------- --------- --------- ---------
Total cost of sales 28,533 31,904 95,503 101,179
--------- --------- --------- ---------
Gross margin 22,709 34,010 83,082 111,515
Operating expenses:
Sales and marketing 17,564 21,944 54,810 65,438
Research and development 9,826 11,128 32,343 32,510
General and administrative 3,280 2,956 9,416 9,417
Restructure costs -- -- 3,383 --
In process research and development 879 -- 879 --
--------- --------- --------- ---------
Total operating expenses 31,549 36,028 100,831 107,365
--------- --------- --------- ---------
Income (loss) from operations (8,840) (2,018) (17,749) 4,150
Other income (expense):
Interest income 2,064 1,459 5,217 4,824
Interest expense (445) (480) (1,400) (1,470)
Other (198) (90) 7,263 564
--------- --------- --------- ---------
Income (loss) before taxes (7,419) (1,129) (6,669) 8,068
Income tax provision (benefit) 12,583 (338) 12,771 2,421
--------- --------- --------- ---------
Income (loss) before extraordinary gain (20,002) (791) (19,440) 5,647
Extraordinary gain on repurchase of debentures -- 56 -- 95
--------- --------- --------- ---------
Net income (loss) $ (20,002) $ (735) $ (19,440) $ 5,742
========= ========= ========= =========
Basic earnings (loss) per share
Income (loss) before extraordinary item $ (0.93) $ (0.04) $ (0.91) $ 0.26
========= ========= ========= =========
Net income (loss) $ (0.93) $ (0.03) $ (0.91) $ 0.27
========= ========= ========= =========
Diluted earnings (loss) per share
Income (loss) before extraordinary item $ (0.93) $ (0.04) $ (0.91) $ 0.26
========= ========= ========= =========
Net income (loss) $ (0.93) $ (0.03) $ (0.91) $ 0.26
========= ========= ========= =========
Shares used in per share calculation
Basic 21,406 21,345 21,375 21,515
========= ========= ========= =========
Diluted 21,406 21,345 21,375 22,019
========= ========= ========= =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4.
<PAGE>
NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands - unaudited)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
------------- -----------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) $(20,002) $ (735) $(19,440) $ 5,742
Other comprehensive income, net of taxes:
Cumulative translation adjustment (52) (34) 38 142
Net unrealized gain (loss) on securities,
net of taxes (214) (418) (7,195) (1,736)
Less: reclassification adjustment for gain (loss)
included in net income (68) (45) 7,445 993
-------- -------- -------- --------
Comprehensive income (loss) $(20,336) $ (1,232) $(19,152) $ 5,141
======== ======== ======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements
5.
<PAGE>
NETWORK EQUIPMENT TECHNOLOGIES, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands - unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
Dec. 26, Dec. 27,
1999 1998
--------- ---------
<S> <C> <C>
Cash and cash equivalents at beginning of period $ 13,720 $ 59,512
Net cash flows from operating activities:
Net income (loss) (19,440) 5,742
Adjustments to reconcile net income to cash
provided by operations:
Extraordinary gain on repurchase of debentures -- (95)
Depreciation and amortization 17,154 15,976
Restricted stock compensation 7 214
Restructure charge 2,985 --
Loss on disposition of property and equipment 471 --
Deferred income taxes 10,943 (1,376)
Changes in assets and liabilities:
Accounts receivable 4,834 12,458
Inventories 3,109 (231)
Prepaid expenses and other assets (2,915) 343
Accounts payable (5,992) (3,579)
Accrued liabilities 323 (5,570)
--------- ---------
Net cash provided by operations 11,479 23,882
--------- ---------
Cash flows from investing activities:
Purchases of temporary cash investments (90,958) (67,940)
Proceeds from maturities of temporary cash investments 116,083 72,131
Purchases of property and equipment (4,719) (28,841)
Additions to software production costs (1,630) (2,421)
Acquisition of company (net of cash acquired) (14,460) --
Other 599 (370)
--------- ---------
Net cash provided by (used for) investing activities 4,915 (27,441)
--------- ---------
Cash flows from financing activities:
Sale of common stock 2,805 4,163
Purchase of common stock (3,775) (5,617)
Repurchase of convertible subordinated debentures -- (955)
--------- ---------
Net cash used for financing activities (970) (2,409)
--------- ---------
Effect of exchange rate changes on cash 196 (188)
--------- ---------
Net increase (decrease) in cash and cash equivalents 15,620 (6,156)
Cash and cash equivalents at end of period $ 29,340 $ 53,356
========= =========
Other cash flow information:
Cash paid (refunded) for:
Interest $ 1,839 $ 1,902
Income taxes $ (6,338) $ (471)
Non-cash investing activities:
Income tax benefit arising from employee stock option plans $ -- $ 578
Net unrealized loss on available-for-sale securities $ (7,195) $ (1,736)
</TABLE>
See Notes to Condensed Consolidated Financial Statements
6.
<PAGE>
NETWORK EQUIPMENT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
1. Basis of Presentation
The consolidated financial statements include the accounts of N.E.T. and
its subsidiaries. Intercompany accounts and transactions have been
eliminated.
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting only
of normal recurring adjustments) considered necessary to present fairly
the financial position as of December 26, 1999, and the results of
operations and cash flows for the quarter and nine months ended December
26, 1999 and December 27, 1998. These financial statements should be read
in conjunction with the March 31, 1999 audited consolidated financial
statements and notes thereto. The results of operations for the nine
months ended December 26, 1999 are not necessarily indicative of the
results to be expected for the fiscal year ending March 31, 2000.
2. Acquisition of FlowWise Networks, Inc.
In December 1999, N.E.T. completed the acquisition of FlowWise Networks,
Inc. ("FlowWise"). The acquisition was accounted for as a purchase. N.E.T.
paid approximately $15.4 million in cash for all FlowWise common and
preferred shares outstanding plus investment banking, accounting and legal
fees of approximately $800,000. N.E.T. also placed $6.6 million in an
escrow account for payments to FlowWise employees who agree to remain as
N.E.T. employees for a period of two years beginning January 2000. These
amounts will be paid out 70% after the first year and the remaining 30% at
the end of the second year. N.E.T. recorded a one time charge of $879,000
in the third quarter of fiscal year 2000 for purchased in-process
technology that had not reached technological feasibility and had no
alternative future use. The remaining portion of the purchase price that
exceeded the net assets of FlowWise, a total of $16.0 million, was
recorded as goodwill and other intangibles that will be amortized on a
straight line basis over five years.
The operating results of FlowWise have been included in the consolidated
statements of operations since the date of acquisition. Had the
acquisition taken place at the beginning of fiscal year 1999, the
unaudited pro forma results of operations would have been as follows for
the nine months ended December 26, 1999 and December 27, 1998 (in
thousands except for per share data):
Nine Months Ended
Dec. 26, Dec. 27,
1999 1998
---- ----
Net revenues $178,835 $212,842
Net loss $(30,523) $ (2,657)
Basic loss per share $ (1.43) $ (0.12)
Diluted loss per share $ (1.43) $ (0.12)
The pro forma results of operations give effect to certain adjustments,
including amortization of purchased intangibles, interest associated with
funding the acquisition and amortization of the amount placed in escrow to
be paid to FlowWise employees. The $879,000 charge for purchased
in-process technology has been excluded from the pro forma results, as it
is a material non-recurring charge.
In determining the fair value of the assets and liabilities acquired from
FlowWise, management has conducted due diligence and has made estimates
and assumptions that affect the reported amounts of FlowWise assets,
liabilities and expense. Actual results could differ from these amounts.
See discussion in the Management Discussion and Analysis of Results of
Operations and Financial Condition ("Management Discussion and Analysis")
on page 11 of this Form 10-Q.
7.
<PAGE>
3. Inventories
Inventories consist of (in thousands):
December 26, March 31,
1999 1999
---- ----
(unaudited)
Purchased components $ 2,122 $ 3,728
Work-in-process 12,199 13,168
Finished goods 1,976 2,297
------- -------
$16,297 $19,193
======= =======
4. Earnings Per Share
Basic earnings per share has been computed based upon the weighted average
number of common shares outstanding for the periods presented. For diluted
earnings per share, shares used in the per share computation include
weighted average common and potentially dilutive shares outstanding.
Potentially dilutive shares consist of shares issuable upon the assumed
exercise of dilutive stock options and totaled 441,000 and 169,000 for the
three months ended December 26, 1999 and December 27, 1998, respectively,
and 220,000 and 504,000 for the nine months ended December 26, 1999 and
December 27, 1998, respectively. Additionally, there were 784,000 shares
of Common Stock issuable upon conversion of debentures. These shares, and
the related effect of the accrued interest on the debentures, were not
included in the calculation of diluted earnings per share for the period
ended December 26, 1999, as their inclusion would have been antidilutive.
5. Comprehensive Income
Accumulated comprehensive income (loss) at December 26, 1999 and March 31,
1999 is comprised of cumulative foreign translation adjustments of
($770,000) and ($808,000), respectively, and cumulative net unrealized
gains (losses) on available-for-sale securities of ($466,000) and
$6,729,000, respectively.
6. Restructure Costs
Quarter 4 Fiscal Year 1999 Restructuring
The Consolidated Statements of Operations for fiscal 1999 included a
charge of $4.7 million, consisting of $4.6 million for employee severance
and other related costs and $119,000 for office closures. A restructuring
provision of $1.3 million remains as of December 26, 1999. N.E.T. will pay
$257,000 during the remainder of fiscal 2000 and $1.0 million in fiscal
2001.
Restructure Remaining
Liability at Paid through Liability at
March 31, 1999 Dec. 26, 1999 Dec. 26, 1999
-------------- ------------- -------------
Compensation $3,540 $2,450 $1,090
Outplacement 499 375 124
Office Closures 119 76 43
------ ------ ------
Totals $4,158 $2,901 $1,257
====== ====== ======
8.
<PAGE>
Quarter 2 Fiscal Year 2000 Restructuring
The Condensed Consolidated Statements of Operations for the nine months
ended December 26, 1999 includes a charge of $3.4 million taken in the
second quarter of fiscal year 2000, consisting of $3.2 million for
employee severance and other related costs and $174,000 for office
closures. A restructuring provision of $997,000 remains as of December 26,
1999. N.E.T. will pay $800,000 during the remainder of fiscal 2000 and
$200,000 in fiscal 2001.
Restructure Remaining
Liability Paid through Liability at
Accrued Dec. 26, 1999 Dec. 26, 1999
-------------- ------------- -------------
Compensation $2,943 $2,240 $ 703
Outplacement 266 89 177
Office Closures 174 57 117
------ ------ ------
Totals $3,383 $2,386 $ 997
====== ====== ======
While N.E.T. does not project any further expenses related to either the
quarter 4 fiscal year 1999 or quarter 2 fiscal year 2000 restructurings,
it cannot be certain that additional expenditures will not be required in
the future.
7. Recently Issued Accounting Standard
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments.
Additionally, in June 1999, the Financial Accounting Standards Board
issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the effective date of FASB Statement No. 133 - an
amendment of FASB Statement No. 133," which defers the effective date of
FASB No. 133 for one year. Adoption of this statement will not impact
N.E.T.'s consolidated financial position, results of operations or cash
flows. This statement is effective for N.E.T. beginning April 1, 2001.
In December 1999, the Securities and Exchange Commission (SEC) released
Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." This bulletin summarizes certain interpretations and
practices followed by the Division of Corporation Finance and the Office
of the Chief Accountant of the SEC in administering the disclosure
requirements of the federal securities laws in applying generally accepted
accounting principles to revenue recognition in financial statements.
Although we have not fully assessed the implications of SAB No. 101, our
management does not believe adoption of this bulletin will have a material
impact on our consolidated financial position, results of operations or
cash flows.
8. Income Taxes
Management of N.E.T. has evaluated the positive and negative evidence
bearing upon the realization of its deferred tax assets. Under the
applicable accounting standards, management has considered the history of
losses and concluded that it is appropriate to fully reserve $18.4 million
during the quarter ended December 26, 1999. This consists of $14.7 million
of deferred tax assets and $3.7 million of equity tax benefits related to
the exercise of non-qualified stock options and purchases under the
Employee Stock Purchase Plan.
9. Subsequent Event
In January 2000, N.E.T. announced a reorganization around its two product
lines, circuit switched or "narrowband" and packet based or "broadband"
products. Implementation of the reorganization resulted in N.E.T. reducing
its workforce, at all levels, by approximately 30% worldwide and closing a
number of its offices worldwide.
The Consolidated Statements of Operations for the fourth quarter ended
March 31, 2000 will include a charge of approximately $12.0 million for
employee severance, other related costs and
9.
<PAGE>
office closures. See Management's Discussion and Analysis Subsequent Event
on page 13 and Business Environment and Risk Factors Reorganization on
page 18 of this Form 10-Q.
10.
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
This discussion and analysis should be read in conjunction with Management's
Discussion and Analysis in N.E.T.'s 1999 Annual Report to Stockholders and Part
I of N.E.T.'s Form 10-K for the fiscal year ended March 31, 1999.
Statements made in this Management's Discussion and Analysis or elsewhere in
this quarterly report or other communications (including press releases and
analyst calls) that are not statements of historical fact are forward-looking
statements, including without limitation, those related to N.E.T.'s future
revenues, gross margins, and other financial and economic targets, trends or
goals. Forward-looking statements are subject to a number of risks and
uncertainties that could cause actual results to differ materially from
statements made, including those discussed in N.E.T.'s Annual Report to
Stockholders for the fiscal year ended March 31, 1999. N.E.T. does not undertake
an obligation to update its forward-looking statements or risk factors to
reflect future events or circumstances.
Acquisition of FlowWise Networks, Inc.
In the third quarter of fiscal 2000, N.E.T. completed the acquisition of
FlowWise Networks, Inc. ("FlowWise") based in San Jose, California. The
acquisition brings to N.E.T. critical Internet Protocol expertise, which is a
major component of N.E.T.'s broadband strategy. The acquisition was accounted
for as a purchase for approximately $16.2 million in cash. N.E.T. recorded a
one-time charge of $879,000 in the third quarter of fiscal 2000 for purchased
in-process technology that has not reached technological feasibility and had no
alternative future use. In addition, the remaining portion of the purchase price
that exceeded the net assets of FlowWise, a total of $16.0 million, was recorded
as goodwill and other intangible assets which will be amortized on a straight
line basis over five years. See discussion in Business Environment and Risk
Factors ("Business Risk Factors") Acquisition of FlowWise Networks, Inc. on page
18 and Note 2 of Notes to Condensed Consolidated Financial Statements of this
Form 10-Q.
Results of Operations
The following table depicts selected data derived from N.E.T.'s Consolidated
Statements of Operations expressed as a percentage of revenue for the periods
presented:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
Quarter Ended Nine Months Ended
------------- -----------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
Percent of Revenue 1999 1998 1999 1998
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Product revenue 47.9 60.7 52.4 62.3
Service and other revenue 52.1 39.3 47.6 37.7
------ ------ ------ ------
Total revenue 100.0 100.0 100.0 100.0
------ ------ ------ ------
Product gross margin 53.8 62.4 57.6 61.6
Service and other revenue gross margin 35.6 34.9 34.3 37.4
------ ------ ------ ------
Total gross margin 44.3 51.6 46.5 52.4
------ ------ ------ ------
Sales and marketing 34.3 33.3 30.7 30.8
Research and development 19.2 16.9 18.1 15.3
General and administrative 6.4 4.5 5.3 4.4
Reorganization expense 0.0 0.0 1.9 0.0
In process R&D 1.7 0.0 0.5 0.0
------ ------ ------ ------
Total operating expenses 61.6 54.7 56.5 50.5
------ ------ ------ ------
Income (loss) from operations (17.3) (3.1) (9.9) 1.9
------ ------ ------ ------
Net income (loss) (39.0) (1.1) (10.9) 2.7
====== ====== ====== ======
- ------------------------------------------------------------------------------------------------
</TABLE>
11.
<PAGE>
Revenue
Total revenue for the third quarter of fiscal 2000 decreased $14.7 million to
$51.2 million, or 22.3%, from the third quarter of fiscal 1999, and decreased
$34.1 million, or 16.0%, on a year-to-date basis. Product revenue for the third
quarter of fiscal 2000 decreased $15.4 million to $24.5 million, or 38.6%, and
decreased on a year-to-date basis $38.8 million, or 29.3%, from the comparable
periods of the prior year. During the third quarter and first nine months of
fiscal 2000, product sales decreased in the North America and European channels
compared to both prior periods. Product sales in the Federal channel for the
third quarter of fiscal 2000 declined from the prior year. N.E.T. believes that
the federal product sales were lower in the quarter as a result of a delay in
the approval of the U.S. government budget, which was approved in early
December. In addition, N.E.T. believes lower product sales resulted from
customers delaying new purchases due to Y2K concerns. Product sales in the
Federal channel increased on a year-to-date basis in fiscal 2000 compared to
fiscal 1999. Partially offsetting the decline further was an increase in fiscal
2000 product sales through the Asia Pacific/Latin America channel for both
periods. Overall, sales of N.E.T.'s circuit switched or "narrowband" products,
which are the majority of N.E.T. products, could vary significantly from quarter
to quarter as customers throughout the world move from circuit switched to
packet or "broadband" technology (see Business Risk Factors Fluctuation of
Operating Results on page 15 of this Form 10-Q).
Service and other revenue for the third quarter and first nine months of fiscal
2000 increased $770,000 to $26.7 million and $4.7 million to $85.0 million,
respectively, from the comparable periods of fiscal 1999. The increases resulted
from other revenue, principally systems integration services, in support of
product sales to the U.S. government. Partially offsetting the increases in
other revenue was a decrease in service revenue for both periods. The decrease
in service revenue has resulted from delay or cancellation of service contracts
in part by key customers with mature, well functioning equipment in their
networks.
Gross Margin
Total gross margin as a percentage of total revenue decreased to 44.3% and 46.5%
for the third quarter and first nine months of fiscal 2000 from 51.6% and 52.4%,
respectively, from the comparable periods of fiscal 1999. The decrease is
primarily the result of lower product revenue as a percent of total revenue for
the third quarter and first nine months of fiscal 2000 from the comparable
periods of fiscal 1999. Management expects the mix between product revenue and
service revenue to be approximately the same for the remainder of fiscal 2000.
Product gross margins decreased to 53.8% and 57.6% for the third quarter and
first nine months of fiscal 2000 from 62.4% and 61.6%, respectively, from the
comparable periods of the prior year. Product gross margins decreased primarily
from unfavorable manufacturing variances that resulted from lower product
revenue volumes. Management expects product gross margins to vary as a function
of volume for the remainder of the fiscal year.
Service and other gross margins increased to 35.6% in the third quarter of
fiscal 2000 from 34.9% in the third quarter of fiscal 1999. The increase was
primarily the result of lower expenses, which resulted from reduced headcount
for service support. Service and other gross margins decreased to 34.9% in the
first nine months of fiscal 2000 from 37.4% in the first nine months of fiscal
1999. The decrease is primarily the result of lower service revenue as a percent
of total service and other revenue. Other revenue, which has lower margins,
increased as a percent of total service and other revenue in the first nine
months of fiscal 2000 compared to the first nine months of fiscal 1999.
Operating Expenses
Operating expenses in the third quarter and first nine months of fiscal 2000
decreased $4.5 million to $31.5 million and $6.5 million to $100.8 million,
respectively, from the comparable periods of fiscal 1999, and increased as a
percentage of total revenue to 61.6% from 54.7% quarter-over-quarter and 56.5%
from 50.5% year-over-year. In the second quarter of fiscal 2000, the Company
completed a restructuring (see Note 6 of Notes to Condensed Consolidated
Financial Statements of this Form 10-Q) that resulted in a reduction in
workforce, which contributed to lower operating costs. Additionally in the third
quarter of fiscal 2000, operating expenses were lower when compared to the third
quarter of fiscal 1999 as a result of lower incentive compensation expenses.
Sales and marketing expenses decreased $4.4 million to $17.6 million and $10.6
to $54.8 million in the third quarter and first nine months of fiscal 2000,
respectively, from the comparable periods of 1999. The
12.
<PAGE>
expense increased as a percentage of total revenue to 34.3% from 33.3%
quarter-over-quarter due to lower sales volume and remained constant on a
year-over-year basis. The decrease in spending resulted from reduced headcount
and lower sales related expenses. Management expects sales and marketing expense
to vary as a percentage of sales volume in the fourth quarter of fiscal 2000.
Research and development expense decreased $1.3 million to $9.8 million and
$200,000 to $32.3 million in the third quarter and first nine months of fiscal
2000, respectively, from the comparable periods of fiscal 1999. The expense
increased as a percentage of total revenue to 19.2% from 16.9%
quarter-over-quarter due to lower sales volume and to 18.1% from 15.3%
year-over-year. Research and development expenses in the third quarter of fiscal
2000 decreased when compared to the third quarter of fiscal 1999 primarily as a
result of lower headcount resulting from the reorganization and employee
attrition. Management expects research and development spending to increase in
the fourth quarter of fiscal 2000 as a result of increased focus on the
broadband strategy and increased headcount from the FlowWise acquisition.
General and administrative expense increased $400,000 to $3.3 million and
remained the same at $9.4 million for the third quarter and the first nine
months of fiscal 2000, respectively, from the comparable periods of fiscal 1999
and increased as a percentage of total revenue to 6.4% from 4.5%
quarter-over-quarter and to 5.3% from 4.4% year-over-year. The higher expenses
are primarily attributable to higher consulting and legal expense partially
offset by lower headcount. Legal expenses increased due to activities related to
the defense of patent infringement claims made by IBM and Lucent (see discussion
in Business Risk Factors section on page 17 of this Form 10-Q). Management
expects general and administrative expense to decrease in the fourth quarter of
fiscal 2000.
Non-Operating Items
Interest income, primarily related to cash investments, increased $600,000 and
$400,000 in the third quarter and first nine months of fiscal 2000,
respectively, from the comparable periods of fiscal 1999. The increase in
interest income is primarily the result of a shift in N.E.T.'s investment
portfolio from tax-exempt securities to taxable securities.
Interest expense, primarily related to the 7 1/4% convertible subordinated
debentures, for the third quarter and first nine months of fiscal 2000 remained
relatively constant with the comparable periods of the prior year.
Other income in the first nine months of fiscal 2000 includes a gain of $7.5
million in the first quarter from N.E.T.'s sale of all of its equity securities
held in a publicly traded company.
The third quarter and the first nine months of fiscal 2000 included a tax
provision of $12.6 million and $12.8 million, respectively. Management of N.E.T.
evaluated the positive and negative evidence bearing upon the realization of its
deferred tax assets. Under the applicable accounting standards, management has
considered the history of losses and concluded that it is appropriate to fully
reserve $18.4 million during the quarter ended December 26, 1999. This consists
of $14.7 million of deferred tax assets and $3.7 million of equity tax benefits
related to the exercise of non-qualified stock options and purchases under the
Employee Stock Purchase Plan.
Subsequent Event
Management initiated a reorganization in the fourth quarter of fiscal 2000. See
Note 9 Subsequent Event of Notes to Condensed Consolidated Financial Statements
on page 9 of this Form 10-Q and Business Risk Factors Reorganization on page 18
of this Form 10-Q. This reorganization is expected to result in a $12.0 million
charge in the fourth quarter for employee severance, other related costs and
office closures. The reorganization will reduce N.E.T.'s workforce at all levels
by approximately 30% worldwide and will include the downsizing and closure of
field offices worldwide. The objective of the reorganization is to increase the
focus on the packet based or "broadband" strategy and more effectively manage
the circuit switched or "narrowband " business. In addition, N.E.T. has
consolidated its sales and service team in Virginia. The reorganization is
expected to reduce current operating expenses by approximately $32.0 million
over the next four quarters. These actions are intended to streamline N.E.T.'s
operations and reduce operating expenses to allow the Company to achieve
profitability at lower revenues.
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LIQUIDITY AND CAPITAL RESOURCES
As of December 26, 1999, N.E.T. had cash, cash equivalents and temporary cash
investments of $141.8 million, as compared to $154.6 million as of March 31,
1999. Cash provided by operations was $13.5 million during the first nine months
of fiscal 2000, which was a $10.4 million decrease from the cash provided by
operations from the comparable period of the prior year. This decrease in cash
was principally the result of a decrease in accounts receivable and a reduction
in net income. Partially offsetting the decline was an increase in cash from
accrued liabilities and inventory.
Net cash provided by investing activities of $4.9 million for the first nine
months of fiscal 2000 consisted primarily of the proceeds from maturities on
temporary cash investments amounting to $116.1 million, partially offset by
purchases of temporary cash investments amounting to $91.0 million. The
acquisition of FlowWise for approximately $16.2 million resulted in a net use of
cash for investing activities of $14.5 million.
Net cash used for financing activities of $1.0 million for the first nine months
of fiscal 2000 pertains to the repurchase of N.E.T.'s Common Stock of $3.8
million partially offset by $2.8 million received from the issuance of Common
Stock relating to the employee stock benefit plan.
As of December 26, 1999, N.E.T. has available a secured $10.0 million line of
credit. N.E.T. has identified $10.0 million as restricted cash on the balance
sheet as of December 26, 1999. Borrowings under this committed facility are
available through May 2000 and would bear interest at the bank's rate (which
approximates prime). At December 26, 1999, there were no outstanding borrowings
under this facility. N.E.T. has identified an additional $6.6 million in
restricted cash on the balance sheet as of December 26, 1999. The cash is
identified for an escrow account that is held for future payouts to FlowWise
employees. See Note 2 of Notes to Condensed Financial Statements of this Form
10-Q.
N.E.T. has in place a share repurchase program that was reauthorized by the
Board of Directors in October 1999. In the third quarter of fiscal 2000, N.E.T.
repurchased approximately 76,800 common shares at an average price of $10.02 per
common share. During the first nine months of fiscal 2000, N.E.T. repurchased
437,700 common shares at an average price of $8.62 per common share. N.E.T.
intends to continue its share repurchase program for the remainder of fiscal
2000 and from time to time will reenter the market to repurchase shares.
N.E.T. believes that current cash and cash equivalents, temporary cash
investments and cash flows from operations will be sufficient to fund
operations, purchases of capital equipment and research and development programs
currently planned at least through the next 12 months.
BUSINESS ENVIRONMENT AND RISK FACTORS
Certain statements contained in this Quarterly Report on Form 10-Q contain
forward looking statements that are based upon current expectations, estimates,
forecasts and projections about the industry in which N.E.T. operates,
management's beliefs and assumptions made by management. Words such as
"expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates,"
variations of these words and similar expressions are intended to identify these
forward-looking statements. Investors are cautioned not to place undue reliance
on these forward-looking statements. These statements are not guarantees of
future performance and involve certain risks, uncertainties and assumptions that
are difficult to predict. Actual outcomes and results may differ materially from
what is expressed or forecasted in any forward-looking statements, whether as a
result of new information, future events, risks identified in this Form 10-Q or
otherwise.
Sales
Historically, the majority of N.E.T.'s revenue in each quarter has resulted from
orders received and shipped in that quarter. In addition, N.E.T.'s backlog at
the beginning of a quarter is generally insufficient to achieve expected net
sales for the quarter. Because of ordering patterns and potential delivery
schedule changes, N.E.T. does not believe that backlog is necessarily indicative
of future revenue
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levels. For the first three quarters of fiscal year 2000, N.E.T. has been
operating without significant backlog and has been scheduling production and
certain expenses based more upon forecasts of sales, which are difficult to
predict. Forecasting sales during a quarter is difficult in part because a large
portion of N.E.T.'s orders historically have been received and filled in the
last month of the quarter. This ordering pattern creates a significant risk of
excessive or inadequate inventory if orders do not match forecast. Furthermore,
if large orders do not close when forecasted or if near-term demand weakens for
the products N.E.T. has available to ship, N.E.T.'s operating results for that
or subsequent quarters would be adversely affected. Additionally, sales for
N.E.T.'s circuit switched products may be negatively impacted by the overall
movement in the telecommunications market from circuit switches to packet
technology. See discussion in Fluctuation of Operating Results below in this
Management's Discussion and Analysis.
N.E.T. has been focusing some of its selling efforts on the emerging global
carrier market including third party leasing programs targeted at this market.
Because companies operating in this market typically do not have either long
operating histories or significant capitalization, financing assistance is often
required to consummate the transaction. In addition to its loss sharing
agreement with BankBoston, N.E.T. entered into a loss sharing agreement with one
of its resellers whereby N.E.T. will share in a percentage of any loss arising
from a customer's failure to pay the reseller for N.E.T. equipment. Should a
significant number of lessees or customers in any one loss sharing pool or
should one large lessee or customer default, N.E.T. could be significantly
impacted both as to revenue and expense.
Further, a significant portion of N.E.T.'s revenue comes from contracts with the
U.S. government, most of which do not include purchase commitments. Orders from
the U.S. government or from other customers may not continue at historical
levels, and it is possible that N.E.T. will not be able to obtain orders from
new customers to make up any shortfall. Should U.S. government orders
substantially decline, Company revenues could be materially adversely impacted
as was the case in the just completed quarter when the delayed signing of the
federal budget caused a delay in Federal sales orders in the quarter.
Fluctuation of Operating Results
Sales of networking products fluctuate based upon a number of factors such as
capital spending levels and general economic and market conditions. Results of
operations in any one quarter are not necessarily indicative of results to be
expected in future quarters. N.E.T.'s operating results may be subject to
quarterly fluctuations as a result of numerous factors including general
economic conditions in the United States and abroad and market conditions
including increased competition. Future declines in networking product sales for
any reason could have a materially adverse affect on N.E.T.'s business,
financial position or results of operations. In particular, the advent of the
Year 2000 may have caused a decline in customer purchases during N.E.T.'s third
fiscal quarter and may continue to cause a decline into the fourth fiscal
quarter. See Year 2000 discussion below in Business Environment and Risk Factors
of this Form 10-Q.
N.E.T. expects that in the future, its net sales may remain below what N.E.T.
has experienced in previous years. The market for circuit switched networking
products could decrease, possibly substantially, as customers in the United
States initially and worldwide thereafter increasingly adopt packet or
"broadband" technologies. N.E.T. cannot predict the speed at which the
transition from circuit to packet technologies will occur. Should the transition
occur more rapidly than N.E.T. has anticipated, it could cause quarterly
variations in product sales and have other adverse affects on N.E.T.'s financial
results.
Additionally, international sales will continue to account for a significant
portion of N.E.T.'s sales in future periods. International sales tend to have
risks that are difficult to foresee and plan for including political and
economic stability, regulatory changes, currency exchange rates, tax rates and
structures, and collection of accounts receivable. In the recent past, events
outside North America, especially in Asia and Latin America, have adversely
impacted N.E.T.'s results of operations. Although there has been improvement in
sales from Asia, future unforeseen events in various areas of the globe may
continue to have an adverse impact on N.E.T. N.E.T. has limited visibility into
factors that could influence its revenue, mix of product orders and other
revenue sources and margins, particularly in international markets that are
served primarily by non-exclusive resellers.
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Competition
N.E.T. competes in the telecommunication equipment market, which is a very
competitive and dynamic market characterized by the easy entrance of new
start-up companies, rapid changes, converging technologies and a worldwide
migration to new packet based technologies. N.E.T. competes directly both
internationally and domestically with a number of different companies that tend
to be either new start-up ventures or large, established suppliers of end-to-end
solutions such as Cisco, Lucent and Nortel. Many of the large suppliers have
greater financial, marketing and technical resources and offer a wider range of
networking products than N.E.T. They are often able to devote greater resources
to the development, marketing and sale of their products. Further, some of these
competitors have large market capitalizations or significant cash reserves that
make them better able to acquire other companies with technology and/or products
that are competitive with N.E.T. Small start-up ventures, on the other hand, are
better able to devote all their resources to a particular product development
unencumbered by the requirements to support an existing product line. As a
result of the market's favorable reaction to recent technology initial public
offerings, start-ups also often have large market capitalizations allowing them
easy access to large amounts of capital for various growth activities including
funding competitive acquisitions. By these acquisitions, competitors can obtain
strategic advantages that may adversely affect N.E.T.'s business, financial
position or results of operations.
In addition, N.E.T. has distribution, resale, product and technology
relationships with a number of significant customers, resellers and other
entities that are considered by N.E.T. to be strategic. In particular, sales
outside the U.S. occur primarily through reseller channels. Most of N.E.T.'s
competitors have similar relationships including relationships with distributors
and resellers who also distribute and resell N.E.T.'s products. Changes in
N.E.T.'s relationships with its distributors or resellers or changes in similar
relationships among competitors or between competitors and N.E.T.'s distributors
or resellers could have a material impact on competitive and business factors,
including N.E.T.'s financial position or results of operations.
Products
N.E.T.'s products incorporate intellectual property and technology owned by
N.E.T. or licensed from third parties. N.E.T.'s ability to maintain and enhance
the value of its intellectual property and technology and third party licenses
will affect future product and service offerings. Moreover, N.E.T. believes that
operating results will depend on successful development and introduction of new
products, in particular packet products, and enhancements to existing circuit
switched products and service offerings. The markets for N.E.T.'s products are
characterized by rapid technological changes, evolving industry standards,
frequent new product introductions and enhancements and significant price
competition. The interaction of these factors could negatively impact the market
for N.E.T.'s existing products as well as for products under development and
thereby adversely affect N.E.T.'s business, financial position or results of
operations.
N.E.T. plans to continue to improve its current circuit based products while
developing and introducing new products for the broadband market. In either
enhancing its current circuit based products or in the development and
introduction of its broadband products, N.E.T. may not be able to successfully
develop and market new or enhanced products, and N.E.T. cannot say for certain
that customers will accept new, enhanced or existing products and services in
quantities and at prices and margins that are consistent with N.E.T.'s
expectations. Further, N.E.T. may not be able to respond effectively to
technological changes or new product announcements by competitors. If N.E.T. is
not able to introduce its broadband products in a timely manner, competitors may
gain market advantage making it difficult for N.E.T. to achieve market
acceptance of these broadband products.
The majority of N.E.T.'s product sales involve a discount from N.E.T.'s standard
list price. Discounting is standard in the sale of networking products. In
fiscal year 2000, N.E.T. implemented a program to price its products to reflect
more accurately the prices charged in the market. It was not the intent of the
program to reduce prices. The program was designed to be revenue neutral so that
while prices were adjusted downward, discounts were adjusted downward as well.
Although it was the intent of the program not to impact margins, there can be no
guarantee that competition or other factors would not require continued
discounting, thereby adversely affecting N.E.T.'s business, financial position
or results of operations.
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Technology
N.E.T. has filed and continues to file patent applications in the U.S. to
protect its proprietary technology in its new products. N.E.T. does not know
whether the patents will be granted and, if granted, whether the claims allowed
will be sufficient to protect N.E.T. technology. Until patents are issued, third
parties could assert infringement claims against N.E.T. and could be successful
in those assertions. In addition, N.E.T. does a material amount of business
outside the U.S. Laws outside the U.S. may not protect N.E.T.'s proprietary
rights to the same degree as do U.S. laws.
N.E.T. has received notice from both IBM and Lucent Technologies of the possible
infringement by certain of N.E.T.'s products of certain IBM and Lucent patents.
N.E.T. is in discussions with both IBM and Lucent and is investigating the
validity of these allegations. Depending upon the outcome of these
investigations, N.E.T. is prepared to either vigorously defend itself or enter
into a licensing agreement with IBM or Lucent on commercially reasonable terms.
There is no guarantee, however, that N.E.T. will be able to negotiate licensing
agreements on commercially reasonable terms or that litigation would not have an
adverse affect on N.E.T.'s business, financial position or results of
operations.
Personnel
N.E.T.'s success depends in part on its ability to attract and retain executive
officers, senior managers and other employees necessary to support planned
revenue goals, such as engineering and sales. N.E.T. has now filled all its
senior level management positions with the acceptance in December 1999 by John
Batty of the position of Senior Vice President and Chief Financial Officer of
N.E.T. Previously, Mr. Batty had served as Chief Financial Officer of Verilink.
Critical for N.E.T.'s future success is the ability to recruit and retain
engineers and sales personnel. The market for engineers in particular is
extremely competitive. N.E.T. must compete for engineering talent against
companies who can provide greater compensation incentives through either
offering stock options for stock with a perceived higher growth value than
N.E.T., or offering a large equity interest in a pre-IPO start-up company.
N.E.T. has taken steps including compensation and other incentives, it hopes
will mitigate these competitive advantages and make it better able to compete
for scarce engineering talent. Additionally, the uncertainties created by
N.E.T.'s restructurings may make it more difficult to retain and hire key
personnel in the near term. Despite N.E.T.'s efforts, its failure to attract,
hire and retain executive officers, senior managers and other key engineering
and sales personnel or the failure of new management, if hired, to execute
Company strategy could have a material adverse affect on N.E.T.'s business,
financial position or results of operations.
Third Party Suppliers
N.E.T.'s products include components, assemblies and subassemblies that are
currently available only from single sources and, in some cases, are in short
supplies. The unavailability of certain components from current suppliers could
result in delayed availability of certain products, thereby adversely affecting
N.E.T.'s business. Testing and manufacturing of products designed by N.E.T. have
generally been outsourced to third parties. Final test and assembly is generally
performed at N.E.T.'s Fremont, California facility. Pursuant to several types of
agreements, N.E.T. also resells products designed or manufactured by third
parties, and N.E.T. relies to a significant degree on these third parties for
order fulfillment, quality control and support of their products. Third party
products are generally sold or licensed by N.E.T. at gross margins that are
lower than products designed and manufactured by N.E.T. Limited availability of
products designed or manufactured by third parties, price increases for such
products, or business interruptions in their manufacture could adversely impact
revenue, gross margin or earnings from such third party products.
Facilities
In April 1998, N.E.T. moved its Corporate headquarters to Fremont, California.
N.E.T. has since discovered problems with what appears to be ground water
infiltration of the buildings and has begun discussion with the lessor under the
building lease and N.E.T.'s commercial insurance carrier regarding a remedy. To
date, N.E.T. has incurred expenses for attorneys and required experts to
evaluate the extent of the problem and for consultants to assist with the filing
of an insurance claim. N.E.T.'s failure to obtain a satisfactory remedy for the
problem could interrupt N.E.T.'s operations to an extent where it could
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adversely impact revenue, financial position or results of operations or
otherwise adversely affect N.E.T.'s operations, revenue, or financial position.
Reorganization
In January 2000, N.E.T. announced a reorganization around its two product lines,
circuit switched or "narrowband" products and packet based or "broadband"
products. As part of the restructuring, the narrowband business will be based
out of Virginia. Job functions associated with narrowband will migrate to Vienna
over time. In addition, N.E.T. is consolidating its sales and service teams in
Virginia with support from small field offices worldwide. To facilitate the
reorganization and reduce expenses, N.E.T. reduced its workforce by
approximately 30% worldwide and will close a number of offices worldwide.
Expenses related to the restructuring will be recognized in the fourth quarter
of the current fiscal year. See Note 9 in Notes to Condensed Consolidated
Financial Statements on page 9 and Management's Discussion and Analysis
Subsequent Event on page 13.
As a result of the reorganization, N.E.T.'s marketing and product development
departments have been split between the Narrowband and Broadband businesses so
that each of these new business units will include marketing and engineering
focused on the respective product line. The Vice President of Product
Development will head the Broadband business unit as its General Manager and the
Vice President of Marketing will head the Narrowband business unit as its
General Manager. Additionally, Ed Peverell, Senior Vice President of Sales and
Service, has announced his retirement and has been replaced by Doreen Jakubcak,
previously serving as N.E.T.'s Vice President of the Americas Sales.
While the intent of the reorganization is to bring increased focus on N.E.T.'s
development of its new broadband products while still supporting its existing
narrowband products, there is no guarantee that the reorganization will result
in the increased focus required to release broadband products in a timely manner
and still adequately support narrowband sales. Employees may not focus
sufficiently on implementation of the broadband strategy because of
preoccupation with the effects of the restructuring. In addition, as a result of
the organizational changes, N.E.T. may lose a significant number of employees
that it had wanted to retain thereby impacting its ability to be successful in
the broadband market. Nor can N.E.T. be certain that even if implemented, its
broadband strategy will be successful. The broadband market may not expand as
quickly as anticipated or that market may not accept N.E.T.'s products.
Acquisition of FlowWise Networks, Inc.
In December 1999, N.E.T. completed its acquisition of FlowWise Networks, Inc.
The purchase of FlowWise provided N.E.T. with Internet Protocol or "IP"
technology expertise necessary for N.E.T. to more effectively develop
competitive products for the emerging broadband market. N.E.T. intends to sell
the FlowWise product as an N.E.T. product and is also considering licensing the
FlowWise technology to others. See Note 2 of Notes to Condensed Financial
Statements in this Form 10-Q and Management's Discussion and Analysis
Acquisition of FlowWise Networks, Inc. on page 11 of this Form 10-Q.
While the intent of the FlowWise acquisition is to enhance N.E.T.'s competitive
position in the broadband market, N.E.T. cannot be certain that the acquisition
of FlowWise will have this result. To be successful, N.E.T. must overcome risks
associated with this acquisition including the possible inability to integrate
the FlowWise technology and products, the possible loss of key FlowWise
employees, and the possible inability of N.E.T. to successfully sell the
FlowWise products due to N.E.T.'s inexperience in the router accelerator market
and the many strong competitors in the larger router market. In addition,
competition, technology changes and other factors may force changes in N.E.T.'s
broadband strategy that may impact the significance of the FlowWise acquisition.
If the FlowWise acquisition proves unsuccessful, it could have an adverse affect
on N.E.T.'s business, financial position or results of operations.
YEAR 2000
THIS STATEMENT IS INTENDED AS A YEAR 2000 READINESS DISCLOSURE.
Introduction
The Year 2000 computer issue had and continues to have the potential to create
risks for all companies, particularly those heavily dependent on or producing
information technology ("IT") products such as
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N.E.T. Management believes that the risk for N.E.T. exists in four principal
areas: potential warranty or other claims from N.E.T.'s customers related to its
products or services, the potential failure of systems used by N.E.T. to run its
business, the potential failure of systems used by N.E.T.'s suppliers and
reduced spending by other companies on networking solutions as a result of
significant information systems spending on Year 2000 remediation and the
lockdown of customer networks in preparation for the Year 2000.
In recognition of this risk, in early 1997, N.E.T. established a Year 2000
compliance team to identify and attempt to minimize the effect of Year 2000
issues on N.E.T. The compliance team assessed the potential impact of the advent
of the Year 2000 on N.E.T.'s products, customers, suppliers and internal
systems, both IT and non-IT. While N.E.T. has not experienced any material year
2000 problems to date, it cannot predict the ultimate outcome of its Year 2000
compliance program. If N.E.T. is not successful in identifying and remediating
Year 2000 problems relating to its internal systems, or if suppliers or
customers material to N.E.T. experience Year 2000 failures, or if customers
temporarily halt the purchase of networking equipment into the year 2000,
N.E.T.'s business, financial position or results of operations may be materially
adversely affected.
Year 2000 to Date
As of the date of the filing of this Form 10-Q, there have been no reports from
customers or resellers worldwide of any material Year 2000 related problems with
any N.E.T. products, whether N.E.T. or OEM manufactured. N.E.T. has not had any
material problems with any of its internal systems and has not had to implement
any of its contingency plans. None of the worst case scenarios discussed in
N.E.T.'s previous SEC filings have come to pass and no implementation of any
N.E.T. contingency plans have proved necessary. At this time, N.E.T. has not
been notified of the intent to file any litigation or take any action by any
customer, reseller or other party against the Company for reasons related to the
advent of the year 2000. While N.E.T. believes that the risks associated with
the advent of the year 2000 have diminished substantially, it cannot be certain
that all problems with N.E.T. products have been reported or that additional
problems may not be discovered. In addition, litigation relating to the year
2000 could yet be filed for any number of reasons including, but not limited to,
requests for refunds from customers who purchased year 2000 product upgrades,
which could have a material adverse affect on N.E.T.'s business, financial
position or results of operations.
Products and Services
N.E.T. completed an evaluation of all its current product offerings to determine
Year 2000 compliance. The majority of the products sold currently by N.E.T. are
Year 2000 compliant. A few products were sold during fiscal year 1999 that were
not compliant; however, these products were not a major source of Company
revenue, and N.E.T. is currently selling no such products. Non-compliant
products are identified in the N.E.T. Products Year 2000 Compliance Program
posted on N.E.T.'s web site (www.net.com). There are certain non-Year 2000
compliant products installed in customer networks that N.E.T. no longer sells.
While N.E.T. has a migration path for many of these products that allows
customers to become Year 2000 compliant, customers may choose not to take
advantage of the available migration path.
In addition to its own manufactured product lines, N.E.T. also resold a number
of products manufactured by third parties. Some of those products carried
N.E.T.'s label and were sold as N.E.T.'s product and warranted by N.E.T.'s
standard product warranty. N.E.T. is relying primarily on the written assurances
of the private label manufacturers as to the Year 2000 compliance of these
products, as N.E.T. cannot independently assess their compliance. For products
resold by N.E.T. but which carry the original equipment manufacturer's label
("OEM products"), N.E.T. passed on to the customer the manufacturer's warranty
rather than N.E.T.'s warranty. Although many OEM products have no Year 2000
problems as they lack a clocking device which would be affected by the advent of
the year 2000, other OEM products contain components vulnerable to the year
2000. N.E.T. obtained from its OEM vendors further protection, if deemed
necessary, for any Year 2000-related problems that may occur. Notwithstanding
N.E.T.'s efforts to seek appropriate protection, there can be no guarantee that
any protection obtained to date will be sufficient to fully protect N.E.T.
should Year 2000-related problems arise. In addition, since N.E.T. is not able
to control the Year 2000 compliance of any OEM products, N.E.T. may face Year
2000 claims should these products fail.
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In addition to the sale of products, N.E.T. also sells post-sale maintenance
services to end users buying products directly from N.E.T. and to its resellers
of product (collectively "customers"). N.E.T. generally does not provide
post-sale maintenance services to customers who purchase products through
resellers ("reseller end users"). The standard written maintenance agreements in
effect since 1992 require N.E.T. to make reasonable efforts to resolve software
errors; however, such standard written maintenance contracts do not otherwise
provide that N.E.T. is to provide the software or hardware necessary to make the
customer's system Year 2000 compliant. Certain older maintenance agreements,
however, primarily those entered into prior to 1992, have broader product
support provisions. While N.E.T. faces greater liability for software errors
under the pre-1992 contracts, because of the limited number of customers
currently receiving maintenance under these early contracts, N.E.T. does not
believe at this time that the exposure is significant.
Customers
N.E.T. posted on its web site the N.E.T. Products Year 2000 Compliance Program,
which provides its customers and resellers with information on the Year 2000
compliance status of N.E.T. products and identifies solutions for achieving
network system and application compliance prior to the year 2000. In late 1997,
N.E.T. mailed the then current Compliance Program Information to the majority of
its customers. In addition, in the second quarter of fiscal year 2000, N.E.T.
identified those direct sale end users and reseller end users that it reasonably
believed had not yet made their equipment Year 2000 compliant and sent a notice
informing them accordingly. Despite all its efforts, N.E.T. cannot guarantee
that customers who were notified of their need to become Year 2000 compliant
took or will take the necessary compliance actions. Substantial portions of
N.E.T.'s sales are to end users outside of the U.S. These sales are primarily
through resellers of N.E.T.'s products. Not all direct sale or reseller end
users, especially those in locations outside the U.S., have undertaken Year 2000
compliance programs. Regions outside of the U.S. were not as focused on the
system problems associated with the advent of the year 2000, and customers in
these regions were slow to take the remedial action necessary to become Year
2000 compliant. Any material inability of N.E.T.'s products to handle the
transition to the year 2000 could result in increased customer satisfaction
issues, servicing costs, potential lawsuits and other material costs and
liabilities.
In addition, while N.E.T. worked with its resellers to ensure that the
reseller's end user base was informed of Year 2000 issues, N.E.T. cannot
guarantee that its resellers communicated sufficiently or accurately with all
their end users, that reseller end users understood the seriousness of the Year
2000 problem, or that those end users took or will take the necessary actions to
fix any Year 2000 problem associated with their installed products.
Year 2000-related litigation to date indicates that direct sale and reseller end
users who have not upgraded their installed products to become Year 2000
compliant may assert warranty, contract, tort, and/or statutory claims against
N.E.T. as a way to recover any damages suffered as a result of the customer's
failure to become Year 2000 compliant. Resellers may assert similar claims, as
well as claims for indemnity, against N.E.T. if the reseller has such claims
made against it by the reseller's end users. Since early 1998, N.E.T.'s product
warranty has limited the warranty provided for Year 2000-related problems. As
N.E.T.'s product warranty runs for one year, N.E.T. does not at this time
foresee significant exposure in the U.S. from product warranty claims involving
Year 2000 compliance. N.E.T. cannot, however, predict with any accuracy how
legislative action or judicial decisions may impact the warranty requirements
placed upon N.E.T. or a customer's ability to successfully prosecute a Year 2000
claim against N.E.T. should one be asserted. N.E.T. believes that the recently
passed federal legislation, the Y2K Act, will be of some assistance in reducing,
or at least deferring, Year 2000 litigation that otherwise might be asserted
soon after January 1, 2000 against N.E.T. The Act will not, however, prevent
such litigation from being filed if the customer follows the procedures
specified in the Act and no resolution of the problem is achieved. To date, no
customers have made claims under the Act in the United States or under any other
legislation or statute elsewhere in the world. If claims were to be asserted in
countries outside the U.S., it would be difficult to predict actions or rulings
outside the U.S. where legal responsibilities and judicial proceedings are not
as well defined and, were unfavorable rulings to occur, there could be a
material adverse affect on N.E.T.'s business, financial position or results of
operations.
20.
<PAGE>
N.E.T. has been informed that some customers may have engaged in a self-help
solution to become Year 2000 compliant by turning back the internal clock in
their network equipment to a year whose sequence of dates is the same as that of
calendar year 2000. The impact to customer networks from this self-help solution
is unknown though no material problems have been reported to date. Depending on
whether the self-help solution is successful, N.E.T. could face increased
liability to either customers whose networks fail due to their decision to turn
the clock back or to customers who purchase Year 2000 compliant systems from
N.E.T. but who allege they could have become compliant through turning back the
clock.
N.E.T. believes its revenue has been adversely impacted by current and
prospective customers devoting a substantial portion of their information
systems spending to evaluation and remediation of Year 2000 issues thereby
diverting money away from spending on networking solutions. This diversion has
been and could continue to have an adverse impact on N.E.T.'s sales volume. In
addition, a number of companies in the United States and elsewhere locked down
their networks in preparation for January 1, 2000 and did not purchase new
network equipment in the last calendar quarter of 1999 and possibly will not
purchase into the first calendar quarter of 2000. Should N.E.T.'s customers
decide not to purchase networking equipment into the first calendar quarter of
2000, these decisions could have a material adverse affect on sales volume and
consequently on revenue for N.E.T.'s fourth quarter of fiscal year 2000.
Internal Systems
The Year 2000 compliance team evaluated Year 2000 issues related to N.E.T.'s
internal systems, both IT systems and non-IT systems, upon which N.E.T. relies
in conducting its business, including financial systems, manufacturing
applications, customer service and support, desktop applications and
infrastructure such as networks, telecommunications products, banking and
financial services, service providers and security systems. N.E.T.'s Year 2000
compliance team may still discover new or additional Year 2000 problems, may be
notified by its suppliers of additional Year 2000 problems for systems
previously believed to be Year 2000 compliant, may not be able to develop and
implement remediation or contingency plans, or it may find that the costs of
these activities exceed current expectations and become material.
Mission-Critical Systems
N.E.T. identified and tested its mission-critical systems to identify Year 2000
problems, if any, and developed plans to remediate, to the extent possible, any
identified Year 2000 problems. Mission-critical systems have been categorized
according to the level of impact a failure would have upon N.E.T., i.e.,
"catastrophic" (causing a shutdown of all or a part of the business) or
"business interrupting" (interrupting system functioning but not causing an
actual shutdown). N.E.T. put in place contingency plans to deal with any impact
of the Year 2000 on all Company mission-critical systems. Despite any
contingency plan, the inability to remedy a Year 2000 problem and the consequent
failure of any internal systems could cause a material disruption in N.E.T.'s
operation.
N.E.T.'s mission-critical systems are compliant with requirements to continue
functioning after the advent of the Year 2000 and in fact, have done so. To the
extent possible, all systems, both mission-critical and non-mission-critical,
are currently Year 2000 compliant although adjustments and upgrades continue to
be required as new problems are uncovered and identified by N.E.T. or its
suppliers.
Third Party Suppliers for Internal Systems
N.E.T. has historically worked with its suppliers to ensure their ability to
meet Company demands. N.E.T. reviewed its mission-critical third party suppliers
to determine the suppliers' Year 2000 compliance as it impacts the services and
products supplied to N.E.T. N.E.T. surveyed the Year 2000 readiness of the
majority of its mission-critical suppliers. The third party supplier reviews did
not uncover any material Year 2000 problems. N.E.T. also evaluated the Year 2000
compliance of products supplied for mission-critical systems and upgraded such
products to be Year 2000 compliant in line with the recommendations made by the
supplier. For all mission-critical suppliers, N.E.T. developed contingency plans
to ensure to the extent possible that any potential business interruption caused
by Year 2000 problems are mitigated. Although no contingency plan has been
implemented to date, should implementation prove necessary in the future, the
cost of implementation may have an adverse affect on N.E.T.'s business,
financial position or results of operations. Third party supplier Year 2000
failures
21.
<PAGE>
remain a possibility and could have an adverse impact on N.E.T.'s business,
financial position or results of operations.
Worst-Case Scenario and Contingency Plans
With the advent of the Year 2000, the potential for experiencing a worst-case
scenario previously identified by N.E.T. in its SEC filings has decreased
significantly. The most reasonably likely worst-case scenario would involve
problems with services and systems supplied by third parties such as
electricity, water, telecommunications, transportation channels and
mission-critical suppliers, rather than from the failure of N.E.T.'s internal
systems. These problems have not materialized to date. N.E.T. developed
contingency plans to deal with the failure of the infrastructure suppliers to
the extent possible. Any contingency plan, however, will be limited by N.E.T.'s
ability to provide infrastructure services normally provided on a large
geographic basis.
Outside N.E.T.'s headquarters facility, Company offices support sales and
service functions. A worst-case scenario previously identified involved
system-wide failures of telecommunications services to locations outside the
U.S. thereby impacting N.E.T.'s ability to engage in sales activities and to
provide post-sale support services to customers outside the U.S. N.E.T.
developed contingency plans to deal with the worldwide full or partial loss of
telecommunications services but to date, these problems have not materialized.
Should N.E.T. lose telecommunications services worldwide for any extended period
of time, or should alternate communications systems not be available, N.E.T. may
be unable to communicate with worldwide locations. This could result in an
inability to process customer orders and/or manufacture and ship products, which
could materially impact N.E.T.'s results of operations. In addition, N.E.T.'s
ability to provide maintenance support to customers with Year 2000 network
problems could be seriously limited as post-sale support relies on telephone
calls or e-mail messages to and from N.E.T.'s Technical Assistance Centers.
While N.E.T. planned for increased calls to its Technical Assistance Centers due
to anxiety on the part of its customer base as the Year 2000 approached, these
calls did not occur. Increased staff was not necessary.
In addition to infrastructure suppliers, N.E.T. identified a worst-case scenario
involving third party suppliers of mission-critical services or systems who are
forced to shut down either partially or completely due to Year 2000-related
system failures. To date, third party suppliers have not experienced material
Year 2000-related problems. While N.E.T. surveyed its mission-critical third
party suppliers to ensure that they are addressing Year 2000 issues and put into
place contingency plans which it believes will help to alleviate supplier
problems, the activities of third parties are outside the control of N.E.T. so
there can be no guarantee that third parties will take the actions necessary to
alleviate Year 2000 issues or that factors not currently foreseeable will not
have a negative impact on N.E.T.'s ability to carry out its contingency plans.
In particular, the contingency plans developed by N.E.T.'s manufacturing
department required that third party suppliers provide additional inventory to
N.E.T. by December 27, 1999. This higher level of inventory may involve
increased costs to N.E.T. and the risk of write-downs in the value of the
inventory if held for a prolonged period of time.
Finally, N.E.T. may not be able to provide or obtain alternate materials or
services in all instances. In its contingency plans, N.E.T. attempted to
identify substitute and second source suppliers. For certain areas of N.E.T.,
substitute or second source suppliers may not be readily available or, if
available, may not be able to quickly supply products or services required.
Risks
If certain internal systems, Company products and third party products are not
Year 2000 compliant, N.E.T. could experience a material negative impact on its
business, financial position or results of operations and relating to factors
that include, among others: diversion of resources by N.E.T. to address and/or
remediate Year 2000 issues; disruption of qualification to sell products in
certain foreign jurisdictions; litigation expense; service delays to N.E.T.'s
customers arising from the failure of vendors, manufacturers and service
providers to adequately address Year 2000 issues; and increased warranty and
other claims by N.E.T.'s customers and/or increased product and system repair,
replacement, service and maintenance obligations under its existing and future
sales, service and maintenance agreements.
22.
<PAGE>
While N.E.T. believes the risks associated with the advent of the year 2000 have
substantially decreased, N.E.T. cannot state there is no risk. Further, N.E.T.
currently cannot accurately assess or estimate the possible impact of the
foregoing risks and liabilities because: the legal standards for Year 2000
liability presently are uncertain, particularly in foreign jurisdictions;
N.E.T.'s Year 2000 obligations will depend on, among other things, the varying
contractual terms contained in its sales, service and maintenance agreements
with respect to the particular customer and the nature of such customer's Year
2000 issue; and there can be no assurance that indemnification or pass-through
arrangements relating to N.E.T.'s sales, service and maintenance agreements will
cover all of N.E.T.'s liabilities and costs incurred in potential Year
2000-related claims.
Notwithstanding, N.E.T. believes that the aggregate cost of resolving the
foregoing issues, defending any claims that may be asserted and satisfying
adverse judgments, if any, could potentially materially and adversely affect
N.E.T.'s business, financial position or results of operations.
Costs
N.E.T.'s efforts to make its internal systems and products Year 2000 compliant
were undertaken largely by using its existing workforce. In a few instances,
consultants were engaged. The costs for all consultants did not exceed $300,000
in total. N.E.T. has spent approximately $1.3 million to date for Year
2000-related costs and currently expects that the total cost of all Year 2000
efforts will not exceed $2.0 million. These cost estimates do not include the
fixed costs involved with employee time spent on Year 2000 matters, nor does it
include costs incurred to test products and make those products Year 2000
compliant as those costs were incurred in 1997 and at that time, were not
separated out from other product development costs. Finally, the cost estimates
provided do not include any potential costs related to customer or other claims
or potential amounts related to executing contingency plans, such as costs
incurred as a result of an infrastructure or supplier failure. N.E.T. has
adequate general funds with which to pay for all expected Year 2000 costs.
N.E.T. expects that expenditures for the Year 2000 compliance of internal
systems will decline after December 1999.
The foregoing statements are based upon management's best estimates at the
present time, which were derived utilizing numerous assumptions of future
events, including the continued availability of certain resources, third party
modification plans, third party assurances of Year 2000 compliance and other
factors. There can be no guarantee that these estimates will be achieved, and
actual results could differ materially from those anticipated.
23.
<PAGE>
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
There has been no material change, except as described below, from the
information as reported in the Form 10-K and Annual Report for the fiscal year
ended March 31, 1999. Refer to the Quantitative and Qualitative Disclosures
section in the Form 10-K and Annual Report for the fiscal year ended March 31,
1999 for information on the financial instruments.
The Company has sold its holdings in the publicly traded investment as disclosed
in its 1999 Annual Report.
24.
<PAGE>
PART II.
OTHER INFORMATION
Item 5. Other Information
On December 6, 1999, the Company appointed John C. Batty as Senior
Vice President and Chief Financial Officer.
Effective December 6, 1999, Robert P. Bowe resigned as Acting Chief
Financial Officer.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27.0 Financial Data Schedule for the nine months ended
December 26, 1999.
(b) Report on Form 8-K
On December 15, 1999, the Company filed a report on Form 8-K
reporting under Item 5 the signing of an Agreement and Plan of
Merger with FlowWise Networks, Inc. for $16 million in cash.
(c) Report on Form 8-K
On December 22, 1999, the Company filed a report on Form 8-K
reporting under Item 5 that revenue for its fiscal third
quarter ending December 26, 1999 was expected to fall short of
expectations, down 15% to 20% sequentially from the second
quarter.
(d) Report on Form 8-K
On January 10, 2000, the Company filed a report on Form 8-K
reporting under Item 2 the acquisition of FlowWise Networks,
Inc. pursuant to a reverse triangular merger.
(e) Report on Form 8-K
On January 26, 2000, the Company filed a report on Form 8-K
under Item 5 that announced plans for a reorganization of the
Company.
25.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETWORK EQUIPMENT
TECHNOLOGIES, INC.
Dated: February 9, 2000 /s/ Hubert A.J. Whyte
--------------------------------------
Hubert A.J. Whyte
President and Chief Executive Officer
/s/ John C. Batty
--------------------------------------
John C. Batty
Senior Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
26.
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