This discussion and analysis should be read in conjunction with the condensed consolidated financial statements included in this Form 10-Q and Part II of our Form 10-K for the fiscal year ended March 27, 2009. Statements contained in this Form 10-Q that are not historical facts are forward-looking statements within the meaning of the federal securities laws that relate to future events or our future financial performance. A forward-looking statement may contain words such as "plans," "hopes," "believes," "estimates," "will," "continue to," "expect to," "anticipate that," "to be," or "can affect." Forward-looking statements are based upon management expectations, forecasts and assumptions that involve risks and uncertainties that may cause actual results to differ materially from those expressed or implied in the forward-looking statements. Many factors may cause actual results to vary including, but not limited to, the factors discussed in this Form 10-Q and our most recently filed Form 10-K. The Company expressly disclaims any obligation or undertaking to revise or publicly release any updates or revisions to any forward-looking statement contained in this Form 10-Q except as required by law. Investors should carefully review any risk factors described in this Form 10-Q and our most recently filed Form 10-K, along with other documents the Company files from time to time with the Securities and Exchange Commission.

Our Business

Network Equipment Technologies, Inc. (NET), founded in 1983, develops and sells voice and data networking solutions that enable the integration and migration of existing networks to secure internet protocol (IP)-based communications. We have more than 25 years of operating history and a worldwide customer base that includes both government entities and enterprise customers. Our enterprise customer base includes large enterprises adopting unified communications (UC) and small- to mid-sized businesses (SMBs) implementing new Voice-over-IP (VoIP) technologies. Our government customers include a variety of federal and international agencies and organizations, including civilian and defense agencies and resellers to such entities. In addition to our direct sales capabilities, we are developing relationships with integrators, resellers and technology leaders to help drive our enterprise business. Our global support and service organization, along with third-party service organizations, provides installation and other professional services, a variety of maintenance programs, technical assistance, and customer training.

Today, our solutions are focused on enabling our enterprise and government customers to cost-effectively migrate to next-generation IP networks, unified communications platforms, secure voice applications, and high-speed multiservice WAN transport networks. Our voice solutions include the VX Series and the Quintum Series of switching media gateways. Our multi-service solutions include the Promina, NX1000 and NX5010 platforms.

Critical Accounting Policies and Estimates

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

Through a contractual arrangement with NET, CACI International Inc. (CACI) has certain rights to provide maintenance and other services to our Federal customers. Under the current arrangement, both companies sell services for NET products, other than the Quintum Series products, and each company is responsible for various aspects of service delivery. CACI provides maintenance support for first-level calls and on-site repairs, NET provides spares logistics and bug fixes, and both companies provide training services. Under a revenue-sharing arrangement, revenue from maintenance and training services is shared between both companies, regardless of which company sells the services. The receipts from sales of these services are shared based on a pre-determined percentage, which is currently 37% for us and 63% for CACI but may fluctuate based upon the total annual amount of sales of these services. As such, 63% of our receipts that are subject to the agreement is remitted to CACI, and conversely, 37% of CACI's receipts that are subject to the agreement is remitted to us. We record amounts derived from sales by us as gross revenue and we record amounts remitted to us by CACI as net revenue. This arrangement expires December 1, 2010, after which we intend to perform these services ourselves and to retain the revenue associated with these services.

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

Other than the items discussed above, there have been no significant changes to our policies and estimates, as discussed in our Annual Report on Form 10-K for the fiscal year ended March 27, 2009.

Recent Accounting Pronouncements

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

Results of Operations

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


                                 Three Months Ended              Six Months Ended
                              September       September      September       September
                               25, 2009       26, 2008       25, 2009        26, 2008
Percent of revenue
Product                          73.0    %      79.2   %        77.1   %      78.3   %
Service and other                27.0           20.8            22.9          21.7
Total revenue                   100.0          100.0           100.0         100.0

Product gross margin             47.8          (31.9 )          50.8          (7.5 )
Service and other gross
margin                           17.1            1.4            14.2          (1.1 )
Total gross margin               39.5          (25.0 )          42.5          (6.1 )

Sales and marketing              23.4           30.7            25.5          33.6
Research and development         24.2           31.4            24.0          35.6
General and administrative       13.8           17.4            14.2          20.6
Restructure and other
(recoveries) costs               (0.1 )          0.9             0.1           1.1
Impairment of goodwill and
long-lived assets                   -          184.7               -         100.3
Total operating expenses         61.3          265.1            63.8         191.2
Loss from operations            (21.8 )       (290.1 )         (21.3 )      (197.3 )

Interest expense, net            (0.9 )         (0.8 )          (0.7 )        (0.8 )
Gain on extinguishment of
debt                                -           34.8             1.4          29.8
Other income (expense), net       1.5           (0.7 )           0.6             -
Loss before taxes               (21.2 )       (256.8 )         (20.0 )      (168.3 )
Income tax provision
(benefit)                           -           (0.3 )           0.1          (0.1 )

Overview and Highlights

Note: Unless otherwise stated, all references to "fiscal 2010" refer to the three and six months ended September 25, 2009; all references to "fiscal 2009" or "the prior fiscal year" refer to the comparable prior year periods, that is, the three and six months ended September 26, 2008; and all comparative references, such as "increases" and "decreases" or "higher" and "lower," refer to the current fiscal 2010 periods as compared to the comparable fiscal 2009 periods.

·

Total revenue in the second quarter of fiscal 2010 was 6.7% higher than in the second quarter of the prior fiscal year and total revenue in the first six months of fiscal 2010 was 15.2% higher than in the first six months of the prior fiscal year . The increase in total revenue was due to greater product revenue from government customers and to the recognition of $1.5 million of externally funded research and development. The increase in product revenue from government customers was partially offset by a reduction in product revenue from our enterprise business, due mostly to a decline in sales of our Quintum product line. The revenue for funded research and development, of which $1.3 million was service and other revenue and $239,000 was product revenue, had been previously deferred and was recognized in the second quarter of fiscal 2010 upon achievement of certain milestones.

·

Our sales to the government sector continue to account for a majority of our revenue. The amount of these sales may fluctuate based upon the timing of orders. As a percentage of total revenue, revenue from government customers was 83.5% and 79.2%, respectively, in the second quarter and first six months of fiscal 2010 compared to 72.6% and 69.0% in the comparable prior-year periods. Spending by government customers is dependent upon the size of budget allocations, the timely passage of the annual federal budget, and the timing of specific programs. We have a number of government customers that purchase, on a regular basis, large quantities of equipment in a single quarter, often with orders totaling between $2 million and $5 million. In some less-frequent cases, orders can be larger, exceeding $5 million. The timing of large orders can affect the timing and mix of revenues. During the second quarter of fiscal 2010, we earned revenue of $5.7 million for NX1000 sales from a single government program. We expect additional revenues through the end of the fiscal year from this program, although in lesser amounts and varying from quarter to quarter. During the second quarter of fiscal 2010, our revenue earned directly or indirectly from General Dynamics (a government contractor), including the $5.7 million for NX1000 sales and the $1.5 million of revenue recognized for funded research and development, was $9.1 million.

·

Promina revenue remains significant, but will continue to decline over time. Our newer NX1000 product has many of the same capabilities of the Promina line and also supports IP trunking. Since Promina products, which are based on time division multiplexing (TDM), remain ideal for certain applications and we have a large installed base, particularly in the government, we expect to continue to see orders for Promina products for the next few years. Promina revenue for the first six months of fiscal 2010 was $9.4 million, a 15.5% decline compared to the first six months of fiscal 2009.

·

Sales of voice-over-IP (VoIP) platforms to government and non-government customers contributed approximately 45.3% of product revenue in the six months ended September 25, 2009 compared to 45.2% for the comparable prior year period. Our VX Series is a VoIP platform with advanced network control and security features. In addition to secure voice applications for the government, the VX Series platform provides enterprise customers with telephony integration for unified communications and unified messaging. VoIP platform revenues in the second quarter and first six months of fiscal 2010 were $4.2 million and $13.7 million, respectively, compared to $5.6 million and $12.1 million in the comparable prior year periods.

·

We expect our mix of product sales and our sector mix to fluctuate quarter to quarter. Our customers continue to move to IP-based communications at varying speeds, and spending by government customers fluctuates for the reasons noted above. The following table shows total revenue from our government customers as well as product revenue from our Promina product and VoIP-based platforms:

  (in thousands, except percentages)     Three Months Ended             Six Months Ended
                                      September      September      September      September
                                       25, 2009       26, 2008       25, 2009       26, 2008
  Revenue from government customers  $ 16,498       $ 13,451       $ 31,120       $ 23,513
  % of total revenue                     83.5   %       72.6   %       79.2   %       69.0   %
  Promina product revenue            $  3,706       $  6,061       $  9,431       $ 11,160
  % of product revenue                   25.7   %       41.3   %       31.1   %       41.8   %
  VoIP-based product revenue         $  4,182       $  5,565       $ 13,714       $ 12,070
  % of product revenue                   29.0   %       38.0   %       45.3   %       45.2   %

·

We continue to manage expenses tightly. Operating expenses in the second quarter and first six months of fiscal 2010 decreased 75.3% and 61.6%, respectively, from the comparable prior-year periods. Operating expenses in the second quarter of fiscal 2009 included charges of $34.2 million related to the impairment of goodwill and other intangible assets. On a temporary basis, most of our domestic employees have taken a 7.5% salary reduction, with executives taking reductions of 10% to 15%. The salary reductions were offset by grants of restricted stock.

·

We retired a further $2.5 million of convertible debt. In the first quarter of fiscal 2010, we used $1.9 million of cash to repurchase and retire $2.5 million principal amount of our 3¾% convertible senior notes at a discount. We realized a net gain of $555,000 on this repurchase. To date, we have repurchased $74.5 million of the total 3¾% convertible senior note offering of $85.0 million, and we have realized net gains totaling $29.2 million on these repurchases. We also repurchased and retired $1.0 million in principal amount of our 7¼% redeemable convertible subordinated debentures and realized a net gain of $353,000 on that transaction.

Revenue

(in thousands,
except              Three Months Ended                       Six Months Ended
percentages)      September     September                 September     September
                  25, 2009      26, 2008     Change       25, 2009      26, 2008     Change
Product           $ 14,420      $ 14,658     (1.6 )%      $ 30,285      $ 26,697      13.4 %
Service and                                                  8,986         7,392
other                5,341         3,857     38.5                                     21.6
Total revenue     $ 19,761      $ 18,515      6.7 %       $ 39,271      $ 34,089      15.2 %

Total revenue was higher in fiscal 2010 primarily due to increased product revenue from government customers, and from the recognition of $1.5 million of revenue for funded research and development, which had been previously deferred and was recognized in the second quarter of fiscal 2010 upon achievement of certain milestones. Total revenue from government customers in the second quarter and first six months of fiscal 2010 was $16.5 million and $31.1 million, respectively, representing increases of 22.7% and 32.4% over the comparable prior-year periods.

Product revenue was down slightly in the second quarter of fiscal 2010. While our U.S. Federal business improved in the second quarter of fiscal 2010, our international government sales were hampered as the British Ministry of Defense processed the repatriation of previously deployed equipment from Iraq and the Balkans prior to making new purchases. Product revenue from our commercial customers was 38.8% lower in the second quarter of fiscal 2010, due primarily to declines in Quintum revenue. Product revenue was higher in the first six months of fiscal 2010 as a result of higher product revenue in the first quarter, due primarily to a 34.9% increase in product revenue from government customers, particularly IP-based platform sales. Product revenue from our commercial customers was 26.1% lower in the first six months of fiscal 2010, due to declines in Quintum revenue. Sales associated with the basic VoIP applications that were a large part of the traditional Quintum business have declined as we shift our focus to more-advanced unified communications, SIP-trunking, and other applications supported by our VX Series products.

Service and other revenue increased primarily as a result of the recognition of the $1.3 million of previously deferred service and other revenue. Significant fluctuations in our service and other revenue can occur as a result of factors affecting the timing of the recognition of revenue, including customer deployment schedules and contractual acceptance provisions.

Gross Margin

                                  Three Months Ended            Six Months Ended
                                September     September     September      September
                                25, 2009      26, 2008      25, 2009       26, 2008
Product gross margin               47.8 %       (31.9 )%        50.8 %        (7.5 ) %
Service and other gross margin     17.1           1.4           14.2          (1.1 )
Total gross margin                 39.5 %       (25.0 )%        42.5 %        (6.1 ) %

Total gross margin increased in fiscal 2010 compared to fiscal 2009 primarily as a result of:

·

One-time impairment charges of $9.7 million recognized in the second quarter of fiscal 2009. There were no similar charges in fiscal 2010.

·

Lower fixed costs. In the second quarter and first six months of fiscal 2010, our fixed manufacturing costs represented 8.8% and 8.3%, respectively, of revenue compared to 10.8% and 12.4% of revenue in the comparable prior-year periods. These reductions in fixed costs resulted from various cost reduction programs.

·

Lower inventory reserve charges. In fiscal 2009, we recorded substantial inventory reserve charges in response to lower product revenue. For the first six months of fiscal 2010, inventory reserve charges represented 4.4% of product revenue compared to 16.2% of product revenue for the first six months of fiscal 2009. The largest portion of our inventory reserves, including those taken in fiscal 2009, were in response to delays in government programs involving our NX5010 product, which had a negative impact on demand for this product, as a new generation of the product was expected in fiscal 2010. We currently believe the unreserved NX5010 inventory balances on hand and owned by our contract manufacturer, Plexus Corp., of approximately $660,000, will be sold prior to the introduction of the new generation products. However, we will continue to evaluate this inventory for possible impairment.

·

There were no charges for amortization of developed technology acquired from Quintum in fiscal 2010. For the first six months of fiscal 2009, amortization of developed technology charged to product cost represented 2.2% of product revenue. We recorded an asset impairment charge for the full carrying value of developed technology in the second quarter of fiscal 2009. Accordingly, there will be no future amortization of developed technology acquired from Quintum.

Service and other gross margin increased as a result of the recognition of the $1.3 million of previously deferred service and other revenue, as well as generally higher revenues and lower costs. Cost savings were realized through headcount reductions and related expense savings.

Operating Expenses

(in thousands,          Three Months Ended                        Six Months Ended
except percentages)   September     September                  September     September
                      25, 2009      26, 2008      Change       25, 2009      26, 2008        Change
Sales and marketing   $  4,628      $  5,692      (18.7 )%     $ 10,020      $ 11,440        (12.4 )%
Research and
development              4,783         5,821      (17.8 )         9,408        12,128        (22.4 )
General and
administrative           2,718         3,222      (15.6 )         5,585         7,013        (20.4 )
Restructure and
other (recoveries)
costs                      (14 )         152     (109.2 )            24           394        (93.9 )
Impairment of
goodwill and long
lived assets                 -        34,197     (100.0 )             -        34,197       (100.0 )
Total operating
expenses              $ 12,115      $ 49,084      (75.3 )%     $ 25,037      $ 65,172        (61.6 )%

Total operating expenses in fiscal 2010 decreased primarily because of the absence of impairment charges which had affected operating expenses in fiscal 2009. Due to the impairment of purchased intangibles in the second quarter of fiscal 2009, there were no charges in fiscal 2010 for amortization of purchased intangibles. Cost control measures implemented in fiscal 2009 also contributed to the decrease in operating expenses. The cost control measures include reduced facilities and information technology costs, which are allocated among the various expense line items. In the near-term future, we expect operating expenses to remain approximately at current levels. However, future operating expenses may fluctuate as a result of new product introductions and other business activities.

Sales and marketing expense decreased in fiscal 2010. The significant changes in sales and marketing expenses were as follows:

·

Cost-reduction initiatives were responsible for the following expense reductions:

o

Payroll-related and consultancy costs were lower by $467,000 and $1.1 million for the second quarter and first six months of fiscal 2010, respectively. Payroll costs were lower in fiscal 2010 due to the effects of lower headcount and temporary salary reductions.

o

Travel and entertainment costs were lower by $152,000 and $373,000 for the second quarter and first six months of fiscal 2010, respectively.

o

Non-cash stock compensation was lower in the second quarter of fiscal 2010 by $74,000.

o

Marketing communication costs were lower by $195,000 and $492,000 for the second quarter and first six months of fiscal 2010, respectively. The higher level of cost in fiscal 2009 was principally due to a new customer acquisition program which ran through the first three quarters of fiscal 2009.

o

Other miscellaneous sales and marketing costs were lower by $150,000 and $234,000 for the second quarter and first six months of fiscal 2010, respectively. There was little change in expenses allocated to sales and marketing, as reductions in company-wide allocated costs were offset by the effect of revised allocations to reflect actual utilization of facilities and services.

·

Due to the impairment charges recorded in the second quarter of fiscal 2009, there was no amortization of purchased intangibles in fiscal 2010. Intangibles amortization expense was $266,000 and $664,000 in the second quarter and first six months of fiscal 2009, respectively.

·

Offsetting these savings, sales commissions were higher for the second quarter and first six months of fiscal 2010 by $240,000 and $464,000, respectively, reflecting higher bookings. Non-cash stock compensation for the first six months of fiscal 2010 was higher by $267,000 due to the effect of restricted stock grants awarded in connection with salary reductions, and employee separation costs of $700,000 incurred in the first quarter of fiscal 2010 in connection with the retirement of our former Federal sales executive.

Research and development expense decreased in fiscal 2010 due primarily to the effect of cost reduction programs as we consolidated our research and development plans into a single company-wide strategy. The significant changes in research and development expenses were as follows:

·

Cost reduction initiatives were responsible for the following expense reductions:

o

Payroll-related and consultancy costs were lower by $988,000 and $2.4 million for the second quarter and first six months of fiscal 2010, respectively. Payroll costs were lower in fiscal 2010 due to the effects of lower headcount and temporary salary reductions.

o

Other research and development expenses, including software and manufacturing production related costs, were $68,000 lower in the first six months of fiscal 2010.

o

Depreciation and other operating expenses were lower by $198,000 and $317,000 for the second quarter and first six months of fiscal 2010, respectively.

o

Allocations of shared expenses, including facilities and information technology costs, were lower by $89,000 and $166,000 for the second quarter and first six months of fiscal 2010, respectively, due to a reduction in company-wide allocated costs and also to revised allocation percentages to reflect actual utilization of facilities and services.

·

These expense reductions were partially offset by non-cash stock option compensation, which was higher by $40,000 and $226,000 for the second quarter and first six months of fiscal 2010, respectively, due to the effect of restricted stock grants, awarded mostly in connection with salary reductions. Also, engineering related costs were $196,000 higher in the second quarter of fiscal 2010 compared to the comparable prior-year period due primarily to new product development costs.

General and administrative expense decreased in fiscal 2010 due primarily to the effect of company-wide cost reduction programs. The significant changes in general and administrative expenses were as follows:

·

Cost reduction initiatives were responsible for the following expense reductions:

o

Payroll related and consultancy costs were lower by $300,000 and $650,000 for the second quarter and first six months of fiscal 2010, respectively. Payroll costs were lower in fiscal 2010 due to the effects of lower headcount and temporary salary reductions.

o

Outside services were $189,000 lower in the first six months of fiscal 2010, as a result of reduced audit fees in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009, partially offset by higher legal fees in the second quarter of fiscal 2010 compared to the second quarter of fiscal 2009.

o

Other operating expenses decreased by $21,000 and $138,000 for the second quarter and first six months of fiscal 2010, respectively.

o

Allocations of shared expenses, including facilities and information technology costs, were lower by $81,000 and $154,000 for the second quarter and first six months of fiscal 2010, respectively, due to a reduction in company-wide allocated costs and also to revised allocation percentages to reflect actual utilization of facilities and services. . . .