**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-K**

 

| **ý****  ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|------------------------------------------------------------------------------------------------------------------|
| **For the Fiscal Year Ended December  31, 2003**                                                                 |
| **OR**                                                                                                           |
| **o****  TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**  |

 

**CommissionFile Number 0-24707**

 

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**INET TECHNOLOGIES, INC.**

(Exact name of Registrantas specified in its charter)

 

| **Delaware**                                                     |   | **75-2269056**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction  of Incorporation or Organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **1500 North Greenville Avenue  Richardson, Texas**              |   | **75081**                             |
| (Address of Principal  Executive Offices)                        |   | (Zip Code)                            |

 

Registrant’s telephonenumber, including area code: **(469) 330-4000**

 

Securities registeredpursuant to Section 12(b) of the Act:

**None**

 

Securities registeredpursuant to Section 12(g) of the Act:

**Common Stock, $0.001 par value**

 

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**Indicate by check mark whether the registrant: (1) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.    Yes ****ý   No****o**

 

**Indicate by check mark if disclosure of delinquent filerspursuant to Item 405 of Regulation S-K is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  ****ý**

 

**Indicate by check mark whether the registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2).  Yes ****ý   No ****o**

 

**The aggregate market value of the voting stock held bynon-affiliates of the registrant on June 30, 2003 was $229,469,605.**

 

**The number of shares of common stock outstanding of theregistrant on January 27, 2004 was 38,945,477.**

 

**DOCUMENTS INCORPORATED BY REFERENCE**

** **

**Certain information required by Parts II and III of this AnnualReport on Form 10-K is incorporated by reference from the registrant’sdefinitive proxy statement to be delivered to stockholders in connection withthe registrant’s 2004 Annual Meeting of Stockholders.**

 

 

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**INETTECHNOLOGIES, INC.**

**FORM 10-K**

**TABLE OF CONTENTS**

 
|      | **PART I**                                                                                       |   |
|-----------|--------------------------------------------------------------------------------------------------|--------|
| Item  1.  | Business                                                                                         |   |
| Item  2.  | Properties                                                                                       |   |
| Item  3.  | Legal  Proceedings                                                                               |   |
| Item  4.  | Submission  of Matters to a Vote of Security Holders                                             |   |
|      |                                                                                             |   |
|      | **PART II**                                                                                      |   |
| Item  5.  | Market  for Registrant’s Common Equity and Related Stockholder Matters                      |   |
| Item  6.  | Selected  Financial Data                                                                         |   |
| Item  7.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations      |   |
| Item  7A. | Quantitative  and Qualitative Disclosures About Market Risk                                      |   |
| Item  8.  | Financial  Statements and Supplementary Data                                                     |   |
| Item  9.  | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure            |   |
| Item  9A. | Controls  and Procedures                                                                         |   |
|      |                                                                                             |   |
|      | **PART III**                                                                                     |   |
| Item  10. | Directors  and Executive Officers of the Registrant                                              |   |
| Item  11. | Executive  Compensation                                                                          |   |
| Item  12. | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters |   |
| Item  13. | Certain  Relationships and Related Transactions                                                  |   |
| Item  14. | Principal  Accountant Fees and Services                                                          |   |
|      |                                                                                             |   |
|      | **PART IV**                                                                                      |   |
| Item  15. | Exhibits,  Financial Statement Schedule and Reports on Form 8-K                                  |   |

 

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**PART I**

 

**Item 1****.  Business.**

 

*This Annual Report on Form 10-K contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended.All statements other than historical or current facts, including, withoutlimitation, statements about our business strategy, plans and objectives ofmanagement and our future prospects, are forward-looking statements. Althoughwe believe that the expectations reflected in such forward-looking statementsare reasonable, such forward-looking statements are subject to risks anduncertainties that could cause actual results to differ materially from theseexpectations. Such risks and uncertainties include, without limitation, thefollowing:*

 

**•**                  *our operating results are difficult to predict andare likely to vary significantly from quarter to quarter in the future;*

 

•                  *we could bematerially harmed in the event of a general economic slowdown, decreasedspending by communications carriers and equipment manufacturers orconsolidations or bankruptcies involving our current or prospective customers;*

 

•                  *we could bematerially harmed if demand for our products is less than we anticipate;*

 

•                  *we could bematerially harmed if the market for current- and next-generation networkproducts and applications fails to develop as we currently anticipate;*

 

•                  *we expect toface increased competition that could result in price reductions and reducedmargins, as well as loss of market share; and*

 

•                  *other risksindicated in Item 7 below under the caption “Risk Factors.”*

 

*These risks and uncertainties are beyond our control and, inmany cases, we cannot predict the risks and uncertainties that could cause ouractual results to differ materially from those indicated by the forward-lookingstatements. When used in this document, the words “believes,” “plans,”“expects,” “anticipates,” “intends,” “continue,” “may,” “will,” “could,”“should,” “future,” “potential,” “estimate,” or the negative of such terms andsimilar expressions as they relate to us or our management are intended toidentify forward-looking statements.*

 

##### **Overview**

 

Inet Technologies, Inc. is a global provider ofcommunications software products that enable communications carriers to morestrategically and profitably operate their businesses. Our Unified AssuranceSolution and our Diagnostics products help our customers reduce capital andoperating expenditures, improve customer acquisition and retention rates, protectand grow revenues, and more quickly and effectively develop products orservices. Our products address next-generation networks, including mobile dataand voice-over-packet technologies, and traditional networks.

 

Using our Unified Assurance Solution, which includesthe GeoProbeTM, OrionTM and BeamerTM products,communications carriers are able to simultaneously manage their voice and dataservices at the network, service and customer layers to detect network andservice problems in real time, enabling proactive identification of specificcustomers or subscriber groups impacted by network or service issues. Theseproducts capture actual network traffic and then process, correlate and analyzethe traffic data to create and display customer experience information, servicequality metrics and a network-wide view. This information empowers a carrier’scustomer service, sales, marketing and network operations organizations toproactively manage the quality of service delivered to its most

 

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valuable customers or select subscriber groups. These products alsoalert the carrier to network problems, such as congestion, misrouted calls dueto equipment errors and service degradation, so that action can be taken toquickly resolve issues, often before its customers are impacted and significantrevenue is lost. Our Diagnostics products include the Spectra2TM,SpectraTM and Spectra Trunk TesterTM, which assistequipment manufacturers and communications carriers in quickly andcost-effectively designing, deploying and maintaining current- andnext-generation networks and network elements.

 

We were founded in 1989, and during the early years ofour operations we focused primarily on developing and selling diagnostics toolsfor a predecessor to the Signaling System 7 (SS7) signaling protocol. Ourinitial Diagnostics product, Spectra, was first introduced in December 1990. Asthe telecommunications industry increasingly adopted SS7, we shifted our focusto developing and deploying SS7-based products as well as broadening ourportfolio of products and applications. In 1993, we began developing amonitoring and surveillance product for SS7 signaling networks, culminating inthe introduction of our network assurance product, GeoProbe, in late 1995.Since the introduction of GeoProbe, we have continued to add capabilities andapplications, including a suite of revenue assurance applications that wasintroduced beginning in late 1999, which was formerly marketed as part of ourIT:sevenTM business intelligence applications. In February 2003, weintroduced Orion, our service assurance product, and Beamer, our customerassurance product. Concurrent with the introduction of our Orion and Beamerproducts, we began to market most of our revenue assurance applications as partof our GeoProbe and Orion product offerings. In recent years, we have enhancedour products to enable them to address new and emerging communicationstechnologies, such as next-generation wireless and voice-over-packet. In 2003,we introduced our initial network assurance products to address General PacketRadio Service (GPRS) mobile data networks and voice-over-packet networks.  In May 2003, we introduced Spectra2 version3.0, our next-generation voice-over-packet test tool.

 

Historically, we have generated substantially all ofour product and license fees revenues from sales of our GeoProbe and Spectraproducts.  Revenues attributable toGeoProbe have represented a majority of our total product and license feesrevenues since 1998.  We expect revenuesfrom our Unified Assurance products will represent a majority of our productand license fees revenues for the foreseeable future.  Carriers can purchase our products individually or as thecomplete Unified Assurance Solution, although most purchases typically includeour network assurance product, GeoProbe. Our services revenues have been derived from services relating to ourproducts, including training, warranty and product support.  The majority of our services revenues consistof warranty and product support services relating to our Unified Assuranceproducts.

 

Our target customers include current- andnext-generation tier-one mobile and fixed-line carriers as well ascommunications equipment manufacturers throughout Europe, North America andselect countries in the Asia/Pacific region. A partial list of our carriercustomers includes Alltel, AT&T, British Telecom, Deutsche Telekom, GlobalCrossing, KT Freetel, MCI, O2, Orange Communications, PTK Centertel,Qwest Communications, Sprint, Swisscom Fixnet, Telstra, T-Mobile USA andVodafone.  A partial list of ourequipment manufacturer customers includes Alcatel, Cisco, Hewlett-Packard,Lucent, Motorola and Nortel.

 

As of December 31, 2003, we had sold our products toapproximately 670 customers in approximately 68 countries. Sales to customersin international markets accounted for approximately 73% of total revenues in2003, approximately 72% of total revenues in 2002 and approximately 62% oftotal revenues in 2001. Sales to customers in the United Kingdom accounted forapproximately 30% of total revenues in 2003, approximately 27% of totalrevenues in 2002 and approximately 19% of total revenues in 2001. Sales tocustomers in Germany accounted for approximately 12% of total revenues in 2003,approximately 11% of total revenues in 2002 and approximately 14% of total

 

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revenues in 2001. No other individual foreign country accounted for 10%or more of total revenues in 2003, 2002 or 2001.

 

**IndustryBackground**

 

*TheCommunications Industry*

 

Deregulation of the communications industry increasedthe competitive landscape by allowing the emergence of more competitivecommunications carriers. The increased competition created by deregulation putpressure on all communications carriers to differentiate themselves fromcompetitors. Differentiation was initially achieved by providing advanced,value-added services and features (such as toll-free “800” numbers, caller ID,three-way calling, voice messaging and Internet access) at compelling priceswith competitive subsidies while delivering a high level of quality of serviceto customers. The result was an increase in the number of communicationsservice providers and options available to consumers.

 

Over the past decade, mobile communications andrelated technologies have been developed to enable mobile communicationsservices to become available at reasonable prices, although initially atquestionable quality levels. Mobile communications carriers have investedheavily in infrastructure and have spent significant sums in acquiring andretaining subscribers to build market share. With the introduction ofnext-generation wireless data technologies, such as GPRS and Universal MobileTelecommunications System (UMTS), many mobile operators are in the process ofdeploying new networks to support the growing demand by consumers for mobiledata services.  Because of theincreasing demand for mobile data services – and the importance of deliveringthese services at high levels of quality – mobile carriers are seekingperformance management products to facilitate the management of these new datanetworks.  Mobile carriers deployingGPRS networks are faced with the challenge of managing multiple technologies –one technology for the existing voice network and another technology for thenew GPRS mobile data network.  Thechallenge of managing multiple technologies is compounded due to the inherentcomplexity of mobile networks, compared to legacy fixed-line networks, which isdriven by the greater volume of signaling messages due to roaming, mobility,Short Message Service (SMS) text messages, customer authentication and wirelesstransactions, in addition to basic call setup. Because of this complexity and thegrowth of mobile data networks, mobile carriers are looking for ways tosimplify network management while concurrently moving towards more proactiveperformance management of the services they deliver to customers and theoverall customer experience.

 

A number of fixed-line carriers have recently startedto design and deploy voice-over-packet networks in an effort to reduceoperating expenses and capital expenditures and simplify network managementthrough the deployment of one network infrastructure to accommodate both voiceand data traffic.  In some instances,certain tariffs can be avoided by routing voice calls over the public Internetor carrier Internet Protocol-based (IP) networks, which may also lower operatingexpenses.  In addition to being a costsaving strategy, voice-over-packet networks provide operators with a revenuegenerating strategy for specific user groups. For example, an operator might target corporate enterprise accounts withservices such as virtual private networks (VPNs), which can include hostedtelephony services, such as IP Centrex, an outsourced solution under which anumber of IP telephony solutions aimed at the needs of business users aredelivered.  To a lesser extent, carriersare beginning to offer IP services to residential users as well.  The rate of adoption of voice-over-packettechnologies varies significantly by geographic region, with most near-termdeployments expected to occur in North America.

 

Over the past few years, the communications industryhas experienced depressed economic conditions with certain communicationsservice providers facing challenging financial

 

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conditions. These factors have contributed to increased consolidationwithin the industry and have forced many carriers to focus on survival.  Today, communications service providers arestill faced with a challenging environment. Most carriers offer similar suites of services, sell them for similarprices and, as a result, are seeking differentiation in the marketplace. One ofthe few strategic differentiators—and one that carriers can control—is thequality of service provided to its customers. To remain competitive, carriersmust provide a high level of service quality and reliability.  To help them achieve this objective,carriers are now focused on implementing performance management solutions thatenable them to not only monitor and manage but also to improve service qualityfor subscribers and key subscriber groups. In addition, the adoption of regulatory requirements enabling mobilenumber portability, which removed a key barrier to switching service providers,has increased carriers’ sensitivity to quality levels being provided tocustomers.  The ability to provide andensure high-performing services to customers is a key to minimizing customerturnover, or churn, in a carrier’s customer base.   In addition to an increased emphasis on quality of servicedelivered, carriers continue to look for ways to reduce network operating costsand capital expenditures, as well as identify new revenue opportunities bybetter utilizing existing network infrastructure or offering value-addedservices, such as data services, to subscribers.

 

*Signalingand the Need for a Unified Approach to Network, Service and Customer Assurance*

 

A communications network must not only conveyinformation between points, it must also determine the best routes forconnections, control the allocation of resources used to transfer theinformation and keep transaction records for billing and measurement purposes.A communications session involves two types of information: the session content(voice, computer data or video) and information about the session (such as theidentities of the party initiating the session and the destination party) thatis required to establish a connection and manage and bill for the session. Thisinformation about the session is generally referred to as signaling, or the“command and control” of the network.

 

Even a relatively simple communications session requiresa sophisticated series of signaling-related transactions. Mobile data, themobility of subscribers, SMS and other advanced services increase the number ofsignaling messages required for each session, which in turn tends to increasethe number of network elements, the complexity of the elements and thesignaling interfaces required in the network. As carriers roll out new servicesand technologies, network complexity increases, which makes performancemanagement more of a challenge.

 

Proactive performance management and the ability tomanage multiple network technologies are necessary for a carrier to achieve aholistic view of its networks. If network problems are not detected on a timelybasis, they can result in service and network downtime, which will result in anegative experience for customers. The challenge with many performancemanagement systems today is the absence of transparency or linkage betweenactual network problems and the services and customers being impacted by theproblems. We believe that for a carrier to truly manage its businessstrategically, it must have the ability to link activity among the network,service and customer layers.

 

Using a unified approach to performance management,once a problem is detected at the network level, operations engineers candetermine what services are being impacted by the problem and, morespecifically, which customers or subscriber groups are experiencing servicedegradation as a result of the problem. Alternatively, if a customer service representativenotices that a specific subscriber group is experiencing quality problems, thetroubleshooting process can be expedited by determining the specific servicesor network elements causing the problem. Once the root cause of the problem isdetermined, operations personnel can prioritize their efforts to focus onresolving the issues that will positively impact the most important customersexperiencing service degradation. We believe that providing a unified view ofinformation across multiple networks and technologies—and linking thatinformation from a network, service and customer perspective—is critical for acarrier to successfully manage the quality of service delivered to itshighest-value customers.

 

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**The InetStrategy**

 

Our mission is to be a leading provider ofcommunications software products and applications for current- andnext-generation communications carriers and equipment manufacturers worldwide.Key elements of our strategy to achieve this objective include:

 

***Continuing to Strive for the Highest Level of CustomerSatisfaction.*** Since our inception in 1989, customer satisfaction has been one of ourprimary goals. Our customers include some of the largest communicationscarriers and equipment manufacturers in the world, and we view our customerbase as one of our greatest assets. Based on experience with our existingcustomers, we believe that achieving early widespread deployment of ourproducts in a particular carrier’s network and achieving high levels ofcustomer satisfaction provide significant ongoing opportunities for sales ofnew and expansion systems, additional applications and other newofferings.  Our repeat customersgenerated in excess of 80% of our revenues in recent quarters.

 

***Developing Products and Applications for the Current- andNext-Generation Mobile Data and Voice-Over-Packet Markets****.*Historically, demand for our products has been driven by the deregulation ofcommunications markets worldwide and growth in fixed-line networks. Today, mostof the large fixed-line and mobile carriers employ basic network managementsystems, such as our GeoProbe product. We believe mobile providers are focused on implementing GPRS and UMTStechnologies, rolling out services on these new technologies and implementingperformance management capabilities to proactively manage these newtechnologies and related services.  Webelieve that this focus on performance management will be necessary for communicationscarriers to maintain or build market share in the extremely competitiveenvironment for mobile services.  Webelieve that this need and the challenges of managing multiple technologieswill generate demand for the products we offer. We also believe largefixed-line carriers are pursuing voice-over-packet technologies and either areor will be rolling out services based on these technologies, which will drivethe need for performance management capabilities.  When deploying a new technology, most carriers typically do nothave the need for a performance management system until networks are deployedand supporting a certain level of subscribers and related traffic.  We therefore believe the adoption of thesenext-generation mobile data and voice-over-packet technologies will also createlonger-term opportunities for us.  As aresult of these factors, the majority of our sales and marketing and productdevelopment efforts are targeted towards the mobile data and voice-over-packetmarkets.

 

***Focusing on Sales to Tier-One Communications Carriers andEquipment Manufacturers in Key Geographic Regions.***  We are pursuing business throughout theworld in markets that we believe offer the most significant and profitablegrowth opportunities. We have made the decision to focus our direct sales andmarketing efforts in Europe, North America and select countries in theAsia/Pacific region with the majority of our efforts targeted toward thecurrent- and next-generation tier-one mobile and fixed-line communicationscarriers and equipment manufacturers. Although the percentage of our revenuesattributable to international markets was approximately 73% in 2003,approximately 72% in 2002 and approximately 62% in 2001, and revenuesattributable to international markets are expected to remain a majority of ourtotal revenues for the foreseeable future, we believe that our expanded productportfolio and the opportunities associated with the deployment of new networksand technologies should enable us to increase our penetration rate in NorthAmerica. We intend to expand our global market share by cultivating ourrelationships with existing customers, targeting large mobile and fixed-linecarriers that are not currently customers and adding resellers in certainmarkets. Our focus on tier-one carriers is fueled by two primary factors.First, the capability of our products to scale to support the world’s largestcommunications networks and the wide range of applications we offer provide uswith a strong competitive position. Second, we believe the tier-one carrierswill survive and emerge from the current slowdown aiming to streamline andoptimize their operations, will seek performance management solutions for thenew

 

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technologies and services they are deploying, and will be willing tocommit the substantial resources required to purchase and maintainsophisticated systems and applications such as the ones we offer.

 

***Investing in Research and Development to ProvideTechnological Leadership and to Broaden Our Product Portfolio****.*  Much of our success to date has been drivenby our ability to develop new products and applications to sell tocommunications carriers and equipment manufacturers. We believe that we havegained significant expertise in communications technologies and relatedsignaling protocols in the course of the design, development and implementationof our current product offerings and through our work with our existingcustomer base. We intend to leverage this core competency and continue toinvest in the strategic area of research and development and to facilitatedifferentiation through the performance, features and scalability of ourproducts as well as the breadth and depth of our product portfolio. We believethat continued research and development investments—for both new productdevelopment and enhancements to our current offerings—will help us maintain orstrengthen our position as a technological leader in our chosen markets. Wealso believe that the addition of new products and applications to our existingproduct portfolio will facilitate our ability to acquire new customers andfurther penetrate our existing customer base. Therefore, we plan to continue toinvest in next-generation communications technologies such as GPRS, UMTS andvoice-over-packet.

 

***Managing Our Business for Profitability****.*    Since our inception, we have managed ourbusiness for profitability. We believe continued profitability is critical tomaintain our high level of investment in new product development, provide apositive future for our employees and create value for our stockholders. Overthe past several years as the economy weakened and demand for our productsslowed, we took actions to align our cost structure with the reduced level ofbusiness. As a result of these actions, we continued to be profitable despite achallenging market environment. We intend to continue to aggressively manageand monitor our cost structure, in light of ongoing business trends.

 

**Inet’sProduct Offerings**

 

We provide communications software products thatenable communications carriers to more strategically and profitably operatetheir businesses. Our product areas include the following:

 

***Unified Assurance Solution***

 

We have been delivering network management systems tocommunications carriers since 1995. We believe the industry landscape haschanged and new trends have emerged in recent years.  Carriers that were once focused on the rapid acquisition ofcustomers at any cost and expansion of their networks have shifted theirefforts to reducing operating and capital expenditures, streamliningoperational support systems and focusing on the service delivered to high-valuecustomers to minimize churn and maximize revenues and profitability. Inaddition, carriers have been investing in next-generation technologies andrelated services and are seeking performance management solutions for these newtechnologies and services.  Because ofthis fundamental change in carriers’ business needs, our product strategy hasevolved and we have broadened our product portfolio.

 

In early 2003, we introduced our Unified AssuranceSolution, which is a proactive performance management solution addressingvarious technologies (GPRS, UMTS, voice-over-packet, SS7), networks (voice anddata) and services (network services and subscriber services).  By using our Unified Assurance products,carriers are able to proactively manage network services addressing subscriberconnectivity issues as well as the commercial services that subscribers pay for.  Our Unified Assurance Solution has theability to capture the actual experience of all subscribers and

 

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select subscriber groups using these services.  There are three components of our UnifiedAssurance Solution:

 

•                  ***Network Assurance****.*  Our principle product that addresses networkassurance is GeoProbe. GeoProbe allows communications carriers to proactivelymonitor, manage and diagnose the overall health of voice and data networksacross multiple technologies based on performance metrics and real-time calltracing and alarming tools. In addition to accelerating problem detection andresolution, network engineers are empowered to make informed capacity planningand traffic management decisions.

 

•                  ***Service Assurance****.*  Our product that addresses service assuranceis Orion. Orion provides carriers with end-to-end performance of subscriberservices in the form of key performance indicators for all subscribertransactions.  For mobile data networks,Orion proactively manages subscriber services and offers automated and guidedtroubleshooting for these services.  Inaddition, we offer two voice service assurance applications, one of whichaddresses interconnection management and another that addresses customer mobilityissues for mobile carriers.

 

•                  ***Customer Assurance****.*  Our product that addresses customerassurance is Beamer. Beamer provides visibility into the actual quality ofservice levels experienced by a carrier’s highest-value customers or selectsubscriber groups and an actionable path to problem resolution.

 

Using our Unified Assurance Solution, communicationscarriers are able to simultaneously manage their voice and data services at thenetwork, service and customer layers to detect network and service problems inreal time, enabling proactive identification of customers impacted by networkor service issues. These products capture actual network traffic and thenprocess, correlate and analyze the traffic data to create and display customerexperience information, service quality metrics and a network-wide view, toempower a carrier’s customer service, sales, marketing and network operationsorganizations to proactively manage the quality of service delivered to itsmost valuable customers.

 

The key benefits of our Unified Assurance Solution includeopportunities for improved acquisition and retention rates of high-valuecustomers or select subscriber groups, streamlined operational support systems,reduced operating expenses and capital expenditures resulting from increasedorganizational efficiencies, informed business planning, and efficientutilization of existing infrastructure. A variety of additional applications will be available for each productso that our customers can customize the system to meet their specific needs andobjectives. Carriers can purchase our products individually or as the completeUnified Assurance Solution, although most purchases typically include ournetwork assurance product, GeoProbe. Our Unified Assurance Solution has been designed on an open architectureallowing easy integration with carriers’ internal systems or third-partyapplications.

 

***Network Assurance***

 

Our product to address network assurance is GeoProbe.GeoProbe, which was initially introduced in late 1995, is used by both mobileand fixed-line communications carriers to proactively monitor, manage anddiagnose the overall health of voice and data networks based on performancemetrics and real-time call tracing and alarming tools. We offer a suite of coreapplications as part of our GeoProbe offering.

 

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Network engineers use GeoProbe for:

 

•                  networkperformance monitoring;

•                  problemdetection acceleration;

•                  informednetwork capacity planning;

•                  trafficmanagement;

•                  proactivetroubleshooting;

•                  revenueassurance; and

•                  networksecurity.

 

GeoProbe’s network-wide monitoring applications enableearly warning of network faults, collection of statistics for networkperformance analysis, real-time and historical call tracing andtroubleshooting. GeoProbe is delivered on an open, purpose-specific hardwareplatform designed by us as a scalable, distributed, multi-processing platform,which non-intrusively captures signaling network traffic and processes the rawdata in real time through multiple software applications. GeoProbe has openinterfaces to allow data delivery to third-party systems.

 

GeoProbe can provide a network-wide view regardless oftopology, number of protocols or number of different vendor elements in use. Itpassively, or non-intrusively, monitors all messages that flow over eachsignaling interface and can automatically correlate these messages in real timeto reconstruct every voice and data session in a carrier’s network. Thiscapability provides session analysis for troubleshooting, problem detection andnetwork integrity assurance. In addition, the information collected by GeoProbeimproves a carrier’s ability to optimize the performance of its network.

 

GeoProbe provides session and network statusinformation to users through a graphical user interface and through web-basedreporting and analysis applications. The graphical user interface displays mapsthat represent network elements, such as Serving GPRS Support Nodes, GatewayGPRS Support Nodes, Mobile Services Switching Centers, Base Station Controllers(BSCs), or Signal Transfer Points (STPs). GeoProbe also provides users with theflexibility to configure their systems to set up triggers to detect events,filters, alarms and statistics based on their specific needs. When failures oruser-specified events occur, an icon representing the affected network elementchanges colors to alert the user to potential trouble or the occurrence of thefailure or event.

 

The platform’s modular design accommodates growth in acarrier’s network and facilitates the implementation of additional capacity ornew applications simply by the addition of processor cards, deployment ofadditional probes and/or additional software.

 

We have developed a number of advanced networkmonitoring software applications for use with GeoProbe, including networksurveillance, troubleshooting and network security applications.  All GeoProbe applications are based on datacaptured directly from the signaling network, and in some cases the actualsession content, as opposed to information provided in vendor-specific formatby individual network elements.  As aresult, carriers can use GeoProbe to gain an independent view regardless ofwhich vendor’s equipment is deployed in their network.  Our open interfaces allow the carrier’s personnelor a third-party software developer to expand or customize existingapplications or develop new applications using data collected by GeoProbe.

 

GeoProbe provides many advantages to a carrier,including an end-to-end view of the network. In the absence of such a globalapproach, carriers must rely on a patchwork of systems scattered throughouttheir networks in order to diagnose problems. This approach typically resultsin optimization at the network element level, which is less effective than anend-to-end network approach.

 

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Another advantage of GeoProbe is its ability tocollect, process and present information in real time, even under extremenetwork load conditions.  This keyattribute makes real-time management and operation of networks possible.  Without a real-time monitoring system,carrier networks are more vulnerable to overloads, fraud and delayed problemresolution, which can lead to network failure, customer dissatisfaction andcompromised network integrity.

 

Other advantages include advanced engineering andproactive planning capabilities. GeoProbe provides an accurate and detailed view of real-time andhistorical statistics on a carrier’s network and the service applicationsdelivered through the network.  Thisallows carriers to implement network architectures optimized for cost andperformance, and to refine the network’s configuration over time based onchanges in demand and traffic patterns. For example, a carrier can use data collected by GeoProbe to identify apoint in the network that is constricting traffic flow.  The carrier can then either reroute trafficor install additional capacity at that point, which increases the throughput ofits entire network.

 

Pricing for a GeoProbe system or individualapplications varies based on a number of factors, such as the volume of networktraffic, network size, network configuration, number of protocols present,number of interfaces monitored and number and type of applications desired.Since 1995, we have sold GeoProbe to approximately 110 customers worldwide.Revenues attributable to GeoProbe have represented a majority of our totalrevenues since 1998.

 

***Service Assurance***

 

Service assurance is the monitoring and delivery by acommunications carrier of subscriber services, such as SMS, multimedia service,e-mail, web browsing and push-to-talk, which is a 2-way radio-type service,similar to a walkie-talkie, that provides instant communications with the touchof a button on a push-to-talk capable handset. Service assurance ensures thathigh levels of service quality are sustained for all subscribers acrossmultiple networks and technologies.

 

Our product that addresses service assurance is Orion,which provides carriers with end-to-end performance data in the form of keyperformance indicators for all subscriber transactions for specific subscriberservices.  The key performanceindicators depict the quality of service delivered as perceived by the subscribers.  For mobile data networks, Orion proactivelymanages subscriber services and offers automated and guided troubleshooting forthese services.

 

Our other service assurance applications addressinterconnection management and customer mobility issues for wireless carriers.The product’s real-time and comprehensive analysis capabilities empower servicemanagers and engineers to immediately initiate corrective actions when servicequality falls below acceptable levels, to implement preventive actions tomaintain service performance integrity and to continuously monitor performancemetrics for planning purposes.

 

Networks are connected among multiple carriers, oftenspanning international boundaries. In addition to monitoring and managing itsown network performance, a carrier must also monitor and manage the performancedelivered beyond its network’s boundaries. Interconnection management is acomplex task for many carriers. Carriers maintain service level agreements(SLAs) with a number of interconnect partners, which define their roles andresponsibilities with respect to interconnection activity, including suchmatters as fees and quality levels. Interconnection-related revenues andexpenses are a core component of a carrier’s business. The failure toproactively manage the quality of interconnection services can have a negativeimpact on a carrier’s business in terms of lost revenue opportunities,increased operating costs and higher customer churn.

 

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One of our service assurance applications, InterconnectionVoice Assurance, addresses interconnection management. Interconnection VoiceAssurance enables mobile and fixed-line carriers to proactively manage andenforce voice traffic SLAs with interconnect partners. A carrier providinginterconnection services to other carriers must proactively manage itsperformance to minimize service quality issues. Alternatively, carriers thatuse interconnect partners to transport voice traffic must monitor theperformance delivered by those partners to ensure that agreed-upon qualitylevels are met.

 

The Interconnection Voice Assurance application’sproactive SLA management capability enables carriers to manage and monitor, inreal time, the transport, delivery and performance of the interconnecting voicecalls they complete.  Flexible alarmsand dynamic displays generated by the application alert operations personnel tonetwork problems preventing interconnect call completions.  Thus, by quickly identifying and resolvingnetwork congestion and other issues, interconnect call completion rates areimproved and interconnection revenues are protected.  Real-time and comparative trending information provides acomprehensive view of all interconnection activity and visibility into eventsoccurring prior to failures.  Voiceperformance metrics and service levels can be tracked by individualinterconnect partner or by served destination.

 

A carrier utilizing other carriers to transportinterconnection traffic can proactively monitor the performance delivered byinterconnect partner providers and take action when performance falls belowacceptable levels.  In addition, usingthe specific carrier and destination performance data provided by theapplication, carriers can make least-cost and best-value routing decisions byoptimizing carrier and route selections. Preferred partners can be selected and utilized based on the overallquality of service provided, or the quality provided to specificdestinations.  Carriers can also useperformance documentation to negotiate more favorable terms with partnerproviders.  Proactive management canreduce the overall costs of interconnection for a carrier.

 

Another service assurance application, InterconnectionMobility Assurance, addresses customer mobility issues for mobile carriers. Theapplication helps measure the quality of service by measuring the mobility andSMS traffic to and from a carrier’s interconnect and roaming partners.

 

Our service assurance applications are web-based andoffer a wide variety of reporting options for the user. The dynamic reportingand analysis tools are fueled by real-time or historical data, depending on thecustomer’s preference, and include instant analysis capabilities, historicalcomparative trending and report personalization. These reporting tools can beused to demonstrate service performance delivered to interconnect partners anda carrier’s own customers. Operations personnel are also able to make moreinformed business decisions given the historical reporting and trendingcapabilities.

 

Pricing for our service assurance product andapplications varies based on a number of factors, such as the number ofsubscriber services monitored, the volume of interconnection traffic and thenumber and type of applications and reporting packages desired.

 

***Customer Assurance***

 

Our product that addresses customer assurance isBeamer. Beamer provides visibility into the actual quality of service levelsexperienced by select subscriber groups. The product helps carriers achieve organizational efficiencies andimprove the acquisition and retention rates of specific customers or selectsubscriber groups that are most desirable and profitable to them.

 

Beamer provides a consistent view of key performanceindicators for all network and subscriber services delivered by a carrier toits high-value customers or any specific group of subscribers. The

 

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product automatically associates network and other relevant activitywith the subscriber, which allows the system to associate both network andservice performance degradation to the subscribers as well as the specificnetwork elements, geographies and other factors involved in delivering theservice. This affords a carrier the ability to identify, prioritize and correctfaults at the network and service layers so that its highest-value customersare addressed first.

 

Beamer also allows a carrier to determine allhigh-value customers being adversely impacted by a common fault so that thepositive impact of corrective efforts is maximized. The product is deliveredvia an open architecture that allows information to be received from GeoProbeand third-party systems.  Beamer’scustomer-associated information may also be extracted and provided tohigher-level service quality tools to address a carrier’s service qualitymanagement initiatives.

 

Pricing for our Beamer product is based on a number offactors, such as the number of end-user customers or subscriber groupsmonitored and the number and type of applications desired. In July 2003, weannounced that we received our initial order for the Beamer product from atier-one European wireless service provider. To date, we have not recognizedany revenues from the Beamer product.

 

***Diagnostics Products***

 

Our Diagnostics products provide equipmentmanufacturers and communications carriers with the ability to quickly andcost-effectively design, deploy and maintain their networks and networkelements. We provide vendor-independent tools that provide diagnostic,emulation and load generation capabilities for use in the design, deployment,commissioning and diagnosis of signaling networks as well as quality of servicemeasurement in voice-over-packet networks. Our Diagnostics products includeSpectra2, which addresses next-generation voice-over-packet networks, andSpectra and Spectra Trunk Tester, which address current-generation networks.These products are also used by developers and equipment manufacturers in thedesign of new products through the products’ extensive emulation andconformance packages and their ability to simulate live network conditions.

 

These multi-protocol diagnostic tools are targeted tothe needs of next-generation networks using H.323, Session Initiation Protocol(SIP), Media Gateway Control Protocol (MGCP), MEGACO (H.248), RealtimeTransport Protocol (RTP) and SIGTRAN protocols. These tools also supportadvanced SS7/C7, Global System of Mobile Communication (GSM), IS-41 and ISDNnetworks and development environments. They are designed for ease-of-use, withan intuitive user interface featuring pop-up menus and single-keystrokecommands. These tools can be configured by the user to change message text andmonitoring scenarios and to save commonly used configurations, filters, testsand other settings for quick setup. They translate complex signaling messagesinto plain language, and the display format shows network statistics and testresults in an easy-to-understand format.

 

Our Diagnostics products provide customers with theability to monitor, emulate and generate signaling data for use introubleshooting, validation, conformance and regression testing of switches andother network equipment. The load generation capabilities and multipleemulation functions can test the various layers of the signaling protocol, upto and including the signaling information involved with complex applications,such as mobile number portability and wireless, and the quality of the mediacarried in the bearer path.

 

These products enable network equipment manufacturersand communications carriers to perform end-to-end testing of applicationsutilizing multiple signaling protocols, including country-specific variationsof signaling. They alleviate the need to use multiple diagnostic tools andprovide

 

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easy and consolidated access to test results. We support over 450national, international and proprietary protocol variants.

 

Prices for a unit generally fall within a range of$40,000 to $70,000.  Since the firstDiagnostics product sale in 1990, over 6,000 units have been sold toapproximately 610 customers worldwide.

 

***Product and Application Development***

 

We utilize an open architecture approach in the designof our products. This approach facilitates and accelerates the development ofnew applications and products and permits us to enhance existing products bysubstituting new hardware or software modules. This modular approach helps toextend the life cycles of our products, simplify the manufacturing process andfacilitate cost reduction.

 

Planned product enhancements for our GeoProbe andOrion products include the ability to monitor UMTS and signaling invoice-over-packet networks as well as the addition of voice and data assuranceapplications. For Beamer, our planned product enhancements include applicationsfor next-generation wireless and voice-over-packet data assurance.

 

Planned product enhancements for our Diagnosticsproducts include increased capacity, higher speed interfaces, passive voiceanalysis and additional support for emerging voice-over-packet and SIGTRANsignaling protocols.

 

**Customers**

 

As of December 31, 2003, we had sold our products toapproximately 670 customers in approximately 68 countries. In 2003,approximately 60% of our total revenues were derived from the 10 largest customersin the period.  In both 2003 and 2002,British Telecom accounted for approximately 21% and Deutsche Telekom accountedfor approximately 11% of our total revenues. In 2001, Deutsche Telekomaccounted for approximately 12% of our total revenues.  See Note 8 of our consolidated financialstatements included in Part IV, Item 15 of this report for a description ofrevenues from customers by geographic region. If we were to lose one or more ofour significant customers, our financial results could be harmed.

 

Our target customers include current- andnext-generation tier-one mobile and fixed-line carriers as well ascommunications equipment manufacturers throughout North America, Europe andselect countries in the Asia/Pacific region. The following is a sampling ofrepresentative customers in various market segments that collectively accountedfor approximately 80% of our total revenues in 2003.

 
| **Long Distance Carriers (IXCs)** |   | **Wireless Carriers**                |   | **PTTs/OLOs***   |   | **Equipment Manufacturers** |
|-----------------------------------|--------|--------------------------------------|--------|------------------|--------|-----------------------------|
| AT&T                          |   | Alltel                               |   | British Telecom  |   | Alcatel                     |
| MCI                               |   | ERA GSM                              |   | Czech Telecom    |   | Cisco                       |
| Sprint                            |   | KT Freetel                           |   | Deutsche Telekom |   | Hewlett-Packard             |
|                              |   | Netcom                               |   | Globe            |   | Lucent                      |
| **Local Exchange Carriers**       |   | O2 (formerly BT  Cellnet)            |   | KPN              |   | Motorola                    |
| Cincinnati Bell                   |   | Orange Communications                |   | Swisscom Fixnet  |   | Nortel                      |
| Qwest Communications              |   | PTK Centertel                        |   | Telstra          |   | Siemens                     |
|                              |   | T-Mobile USA (formerly  Voicestream) |   | Telenor          |   | Sonus Networks              |
|                              |   | TMN Telecomunicacoes                 |   |             |   | Spatial Wireless            |
| **Next-Generation  Carriers**     |   | Taiwan Cellular                      |   |             |   |                        |
| Global Crossing                   |   | Vodacom                              |   |             |   |                        |
| Level 3 Communications            |   | Vodafone                             |   |             |   |                        |

 

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** Post Telephone & Telegraph Administrators and OtherLicensed Operators.*

 

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**Sales,Marketing and Support**

 

***Sales and Marketing***

 

We sell our products to communications carriers andequipment manufacturers globally through both direct and indirect channels.Domestically, the direct channel is used for all product areas. Our domesticsales force is structured around a two-tiered model focused on strategicaccounts and geographic areas. Internationally, we use both direct and indirectchannels. Our Unified Assurance products are sold directly and, in certaingeographic regions, in cooperation with systems integrators, resellers andconsultants, while our Diagnostics products are sold primarily throughresellers. As of December 31, 2003, we had four sales offices in the U.S. andfour sales offices outside the U.S., near the cities of London, England;Frankfurt, Germany; Paris, France and Milan, Italy.  We also have a direct sales presence in Sydney, Australia, inTokyo, Japan, in Seoul, Korea, in Singapore and in Madrid, Spain.

 

The sales cycle for our products can be long,historically averaging from six to 18 months for our Unified Assurance products(excluding the cycle for subsequent applications and enhancements, which varieswidely) and averaging three months for occasional, large sales of ourDiagnostics products.

 

Our primary marketing activities include raisingpotential customer awareness of the benefits of proactive performancemanagement as well as identification of new opportunities with existingcustomers. An initial system sold to a new customer typically contains alimited number of applications and may only monitor a portion of its networkinfrastructure. Over time, as the customer becomes more familiar with thesystem, as its operating needs change or as traffic patterns increase, it maypurchase additional footprint coverage and applications. Also, our introductionof new products and applications provides additional sales opportunities to ourexisting customers. We market primarily through direct sales and marketingefforts, advertising in trade publications, exhibitions at industry trade showsand presence on the Internet through our Web site. These activities focus ongenerating qualified sales leads and demonstration opportunities for ourproducts.

 

We provide extensive training and support to ourdirect sales force and our worldwide resellers, including classroom training,product brochures, demonstration systems and promotional literature.

 

***Customer Operations, Services, Support and Warranty***

 

We believe that customer service, support and trainingare important to building and maintaining strong customer relationships. Weservice, repair and provide technical support for our products. We currentlyoffer two levels of support services that provide either 24-hour, seven days aweek, or 8-hour, five days a week technical support. Both levels provide forremote access assessment and servicing capabilities, installation support andadvance replacements for emergency situations.

 

We maintain an in-house repair facility and provideon-going telephone assistance to customers from our support center inRichardson, Texas. In addition, we service our customers from product supportoffices located near the cities of London, England and Frankfurt, Germany. Asour customers become more geographically diverse and as business conditionswarrant, we may open support offices in other key locations.

 

We typically warrant our products against defects inmaterials and workmanship for one year. We also provide varying levels ofextended product support under support services agreements. Support servicesagreements are typically sold to customers for a one-year term and may berenewed for additional one-year periods. Customers that do not renew theirsupport services agreements but

 

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wish to obtain product updates and new version releases generally arerequired to purchase such items from us at market prices.

 

**Researchand Development**

 

Our primary development facilities are located at ourRichardson, Texas headquarters. Our research and development efforts includeexpenditures for new products, new applications, new features or enhancementsfor existing products or applications and sustaining engineering activities.Approximately 90% of our research and development personnel are focused on thesoftware component of our products. Our research and development expenses were$29.8 million in 2003, $29.8 million in 2002 and $39.3 million in 2001. See“—Inet’s Product Offerings—Product and Application Development” for adiscussion of current and planned product enhancements.

 

Our products and applications are designed to complywith a significant number of standards and regulations, some of which areevolving as new technologies are deployed. For sales to customers in the U.S.,our products must comply with various standards established by TelcordiaTechnologies, Inc. and the American National Standards Institute.Internationally, our products must comply with standards established by theEuropean Union, communications authorities in various countries as well asrecommendations of the International Telecommunications Union and the EuropeanTelephone Standards Institute.

 

**Manufacturing**

 

Our products are comprised of both third-party andpurpose-specific hardware. Third-party hardware consists primarily of serversand workstations, which are standard devices configured for our specific needs.For purpose-specific hardware, our internal production process consists ofprocurement and inspection of various components, primarily circuit boards andracks; final system assembly; system burn-in and quality control testing; andpackaging. Internal integration processes are performed primarily at ourheadquarters in Richardson, Texas. We outsource the manufacturing of ourproprietary hardware to a number of Texas-based contract manufacturers.

 

We generally use industry-standard components, whichare available from multiple sources. However, our products currently utilizevarious components that are available from only one manufacturer or a limitednumber of suppliers. We attempt to minimize the need for sole and limitedsource components when feasible by performing design reviews prior to themanufacture of any new product or redesign of an existing product. We forecastour parts usage on an ongoing basis and meet with key vendors to obtain theircommitment to meet forecasted supply needs. As necessary, we reevaluate thesources of components identified as having potential delivery or other risksand the costs and benefits of redesigning our products to incorporatealternative components. If any sole or limited source components should becomeunavailable, we believe that we could design similar functionality into ourproducts using other components, although the amount of time and effortrequired could vary widely depending on the product involved and the functionand complexity of the component.

 

**Competition**

 

We compete principally with a number of U.S. andinternational suppliers that vary in size and in the scope and breadth of theproducts and services offered. Our Unified Assurance products principallycompete with products offered by Agilent Technologies and, to a lesser extent,products offered by NetTest and Steleus. With respect to our service assurance and customer assurance offerings,we compete to a lesser extent with systems developed internally by current andprospective customers.  In certaincases, a carrier may seek the functionality we offer as a component of a

 

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broader service quality management system, which would typically beimplemented by large system integrators, like Accenture or CapGemini, or we maycompete with system integrators if they decide to develop the performancemanagement component of the solution themselves or integrate the products fromour competitors or other companies.  OurDiagnostics products principally compete with products offered by AgilentTechnologies, Catapult Communications, Empirix, and Spirent.

 

We believe that our competitive advantage is driven byour sophisticated technology and product architecture as well as the fact thatwe continue to introduce new products and applications to help our customersleverage their existing investment in our products. The ability of our productsto collect, correlate and process data in real time is a key differentiator forus. We also believe that the scalability of our systems and the breadth of ourproduct and application portfolio affords us an advantage compared to ourcompetition. Certain of our competitors have, in relation to us, longeroperating histories, larger installed customer bases, longer-standingrelationships with customers, greater name recognition and significantlygreater financial, technical, marketing, customer service, public relations,distribution and other resources. We believe that our ability to competesuccessfully depends on numerous factors, both within and outside our control,including:

 

•                  responsivenessto customer needs;

 

•                  ourability to support existing and new industry standards;

 

•                  thedevelopment of technical innovations;

 

•                  theattraction and retention of qualified personnel;

 

•                  regulatorychanges;

 

•                  thequality, reliability and security of our products and services and ourcompetitors’ products and services;

 

•                  sufficientmarket presence by us;

 

•                  theease of use of our products;

 

•                  thepricing policies of our competitors and suppliers;

 

•                  thetiming of introductions of new products and services by us and our competitors;and

 

•                  generalmarket and economic conditions.

 

**ProprietaryRights**

 

Our continued success is dependent in part upon ourproprietary technology. To protect our proprietary technology, we rely on acombination of technical innovation, trade secret, copyright and trademarklaws, non-disclosure agreements and, to a lesser extent, patents, each of whichaffords only limited protection. In addition, the laws of some foreigncountries do not protect our proprietary rights in the products to the sameextent as do the laws of the U.S. We hold several U.S. patents, and although wehave additional patent applications pending, we cannot assure you that we willbe granted additional patents. Despite the measures taken by us, it may bepossible for a third party to copy or otherwise obtain and use our proprietarytechnology and information without authorization.

 

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We rely upon certain software that we license fromOracle Corporation, Cognos Incorporated and other third parties, includingsoftware that is integrated with our internally-developed software and used inour products to perform key functions.

 

The trademarks Inet, Inet Technologies, GeoProbe,Unified Assurance, Bearner, Orion, Spectra, Spectra Trunk Tester, Spectra2 andVIA used herein are registered or unregistered trademarks owned by us.  Other trademarks are owned by theirrespective owners.

 

**Employees**

 

As of December 31, 2003, we had 483 employees, ofwhich 245 were engaged in research and development, 66 were engaged in salesand marketing, 127 were engaged in operations and 45 were engaged inadministrative and other business support functions.

 

# ***WhereYou Can Find Other Information***

 

We file annual, quarterly, current and other reports,proxy statements and other information with the Securities and ExchangeCommission, or SEC, pursuant to the Securities Exchange Act of 1934, asamended, or the Exchange Act.  You mayread and copy any materials we file with the SEC at the SEC’s Public ReferenceRoom at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtaininformation on the operation of the SEC’s Public Reference Room by calling theSEC at 1-800-SEC-0330.  The SECmaintains an Internet site that contains reports, proxy and other informationstatements, and other information regarding issuers, including us, that fileelectronically with the SEC.  Theaddress of that site is http://www.sec.gov.

 

We maintain an Internet site, the address of which iswww.inet.com.  We make available free ofcharge through this site, under the heading “SEC Filings” at the addresshttp://www.inet.com/newweb/investors, our Annual Report on Form 10-K, QuarterlyReports on Form 10-Q, Current Reports on Form 8-K, and amendments to thosereports filed or furnished pursuant to Section 13(a) or 15(d) of the ExchangeAct as soon as reasonably practicable after we electronically file suchmaterial with, or furnish it to, the SEC.

 

**Item 2****.    Properties.**

 

We are headquartered in Richardson, Texas, under alease that expires in 2010. In the U.S., we also lease offices for salespersonnel in California, New Jersey, Pennsylvania and Washington. These leasesexpire on various dates through 2004. Outside the U.S., we lease offices nearthe cities of London, England; Frankfurt, Germany; Paris, France and Milan,Italy. These leases expire on various dates through 2013.

 

**Item 3****.    Legal Proceedings.**

 

We are involved in various legal proceedings andclaims that arise in the normal course of our business. While many of thesematters involve inherent uncertainty, our management believes that the amountof the liability, if any, ultimately incurred by us with respect to anyexisting proceedings and claims, net of applicable reserves and availableinsurance, will not materially harm our business, financial condition orresults of operations.

 

**Item 4****.    Submission of Matters to a Vote of SecurityHolders.**

 

No matters were submitted to a vote of securityholders during the fourth quarter of 2003.

 

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**PART II**

 

**Item 5****.  Market for registrant’s Common Equity andRelated Stockholder Matters.**

 

Our common stockis listed on The NASDAQ Stock Market under the symbol “INTI.” The followingtable sets forth, for the periods indicated, the high and low sales prices forour common stock as reported on The NASDAQ Stock Market.

 

|           |   | **High** |   | **Low** |   |
|----------------|--------|----------|--------|---------|--------|
| **2003**       |   |     |   |    |   |
| Fourth Quarter |   | $        | 14.60  |    | $      | 11.09 |   |
| Third Quarter  |   | 16.00    |   | 9.76    |   |
| Second Quarter |   | 10.50    |   | 5.87    |   |
| First Quarter  |   | 8.25     |   | 5.78    |   |
|           |   |     |   |    |   |
| **2002**       |   |     |   |    |   |
| Fourth Quarter |   | $        | 6.98   |    | $      | 4.15 |   |
| Third Quarter  |   | 6.68     |   | 4.00    |   |
| Second Quarter |   | 10.30    |   | 5.71    |   |
| First Quarter  |   | 11.05    |   | 7.91    |   |

 

 

 On January 27, 2004, the last reported salesprice of our common stock on The NASDAQ Stock Market was $16.31 per share.  As of January 27, 2004, there wereapproximately 160 stockholders of record (not including beneficial holders ofstock held in street name) of our common stock.

 

We have never paid cash dividends on our common stockand do not intend to pay cash dividends on our common stock in the foreseeablefuture. Future dividends, if any, will be determined by our board of directors.

 

On May 26, 1999, the Securities and ExchangeCommission, or SEC, declared effective our registration statement on Form S-1(File No. 333-59753) relating to the initial public offering of our commonstock.  As of December 31, 2003, we haveused all of the net offering proceeds for the purchase of temporaryinvestments, consisting of cash, cash equivalents, short-term investments andtreasury shares.  We currently intend touse the net proceeds of the offering for working capital and general corporatepurposes, including financing accounts receivable and capital expenditures madein the ordinary course of business.  Wealso may apply a portion of the proceeds of the offering to acquire businesses,products and technologies, or enter into joint venture arrangement that couldcomplement or expand our business and product offerings. However, at this timewe have not identified a specific acquisition or joint venture or allocated aspecific amount for this purpose.

 

Information called for by Item 5 regarding securitiesauthorized for issuance under our equity compensation plans will be includedunder the caption “**Proposal 2, Amendment of 1998 Employee Stock PurchasePlan**” in our Proxy Statement for the 2004 Annual Meeting ofStockholders, which information is incorporated in this Annual Report byreference.

 

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**Item 6****.    Selected Financial Data.**

 

The selected consolidated financial data below shouldbe read in conjunction with Item 7, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations,” and our consolidated financialstatements included in Part IV, Item 15.

 
|                                            |   | **Years Ended December 31,**              |    |
|-------------------------------------------------|--------|-------------------------------------------|---------|
|                                            |   | **2003**                                  |    | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                                            |   | **(in thousands, except per share data)** |    |
| **Statements of  Operations Data:**             |   |                                      |    |   |   |   |   |   |   |   |   |
| Revenues                                        |   | $                                         | 103,819 |   | $ | 101,886 |   | $ | 107,015 |   | $ | 159,007 |   | $ | 109,983 |   |
| Income (loss) from operations                   |   | 15,211                                    |    | 8,028 |   | (6,391 | ) | 51,238 |   | 34,752 |   |
| Income (loss) before provision for income taxes |   | 16,441                                    |    | 10,782 |   | (1,097 | ) | 59,422 |   | 44,663 |   |
| Net income                                      |   | 11,691                                    |    | 7,609 |   | 193 |   | 39,521 |   | 29,701 | (1) |
| Earnings per share (2):                         |   |                                      |    |   |   |   |   |   |   |   |   |
| Basic                                           |   | $                                         | 0.30    |   | $ | 0.16 |   | $ | 0.00 |   | $ | 0.86 |   | $ | 0.68 |   |
| Diluted                                         |   | 0.30                                      |    | 0.16 |   | 0.00 |   | 0.84 |   | 0.66 |   |
| Weighted-average shares outstanding (2):        |   |                                      |    |   |   |   |   |   |   |   |   |
| Basic                                           |   | 39,059                                    | (3)     | 46,964 |   | 46,633 |   | 46,126 |   | 43,449 |   |
| Diluted                                         |   | 39,517                                    | (3)     | 47,084 |   | 47,087 |   | 46,885 |   | 45,037 |   |

 
|                      |   | **December 31,**   |    |
|---------------------------|--------|--------------------|---------|
|                      |   | **2003**           |    | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                      |   | **(in thousands)** |    |
| **Balance Sheet  Data:**  |   |               |    |   |   |   |   |   |   |   |   |
| Cash and cash equivalents |   | $                  | 118,527 |   | $ | 189,076 |   | $ | 154,889 |   | $ | 131,419 |   | $ | 127,903 |   |
| Short-term investments    |   | 55,034             |    | — |   | — |   | — |   | — |   |
| Working capital           |   | 165,464            |    | 182,459 |   | 170,116 |   | 167,161 |   | 123,909 |   |
| Total assets              |   | 211,344            |    | 228,174 |   | 211,528 |   | 226,207 |   | 169,917 |   |
| Stockholders’ equity |   | 177,624            |    | 197,956 |   | 188,483 |   | 185,420 |   | 133,423 |   |
|                           |        |                    |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)       Includesa gain of $5.9 million from the sale of our wireless data assets in September1999.

 

(2)       See Note 1 to our consolidated financial statements for the determinationof shares used in computing basic and diluted earnings per share.

 

(3)       On January 21, 2003, we repurchased in aprivately-negotiated transaction 8,969,984 restricted shares of our commonstock from Mark A. Weinzierl, one of our founders.

 

**Item 7****.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

Inet Technologies, Inc. is a global provider ofcommunications software products that enable communications carriers to morestrategically and profitably operate their businesses. Our Unified AssuranceSolution and our Diagnostics products help our customers reduce capital andoperating expenditures, improve customer acquisition and retention rates,protect and grow revenues, and more quickly and effectively develop products orservices. Our products address next-generation networks, including mobile dataand voice-over-packet technologies, and traditional networks.

 

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**Overview**

 

This Management’s Discussion and Analysis of FinancialCondition and Results of Operationsprovides information that our management believes to be necessary to achieve aclear understanding of our financial statements and results of operations.

 

Our management monitors and analyzes a number of keyperformance indicators in order to manage our business and evaluate ourfinancial and operating performance. Those indicators include:

 

•                  *Revenues*.  We derive revenues from product and licensefees and services relating to our products. These revenues vary based on such factors as demand for our products,the number and size of transactions within the reporting period and the impactof changes in our sales prices.  Inaddition to monitoring the amount of our product and license fees revenues,services revenues and total revenues, we also consider revenue concentration bycustomer and by geographic region to be important indicators of trends in ourbusiness.

 

•                  *Costs ofrevenues and gross margins*. We strive to control our cost of revenues and thereby maintain orimprove our gross margins.  The majoritems impacting cost of product and license fees are hardware and third-partysoftware, personnel and overhead expenses. Hardware and third-party software costs will vary significantly based onthe relative mix in the period of implementations of new systems versusexpansions of existing systems and software application sales. New systemstypically have a higher hardware and third-party software component, resultingin a lower gross margin.  Cost ofservices is driven primarily by personnel expenses.  These costs tend to fluctuate as a result of the relative mix ofproduct support and training activities during a specific period.

 

•                  *Operatingexpenses*.  Operating expensesare substantially driven by personnel and overhead expenses. Other significantoperating expenses that we monitor include travel, professional fees andfacilities and communication expenses.

 

•                  *Liquidityand cash flows*.  The primarydriver of our cash flows is our net income. The primary source of our liquidity is our cash reserves and short-terminvestments.  From period to period, wesee fluctuations in various items, including our working capital accounts,capital expenditures and proceeds from the exercise of employee stock optionsand stock purchases.

 

•                  *Balancesheet*.  We view cash,short-term investments, working capital, inventory, accounts receivable balancesand days sales outstanding as important indicators of our financial health.

 

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**Results of Operations**

 

***Revenues***

 

The following table sets forth,for the periods indicated, a year-over-year comparison of the key components ofour revenues:

 

|                                    |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|-----------------------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **($ in  millions)**                    |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Product and license fees                |   | $        | 73.0   |     | $      | 74.6              |   | $      | (1.6   | )                 | (2     | )% | $ | 84.1 |   | $ | (9.5 | ) | (11 | )% |
| Services                                |   | 30.8     |   | 27.3     |   | 3.5               |   | 13     |   | 22.9              |   | 4.4 |   | 19 |   |
| Total revenues                          |   | $        | 103.8  |     | $      | 101.9             |   | $      | 1.9    |              | 2      | % | $ | 107.0 |   | $ | (5.1 | ) | (5 | )% |
|                                    |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Top 10 customers as % of total revenues |   | 59.9     | %      | 57.2     | %      |              |   |   |   | 55.6              | %      |   |   |   |   |
|                                    |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Revenues from international markets:    |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Asia/Pacific                            |   | 7.6      | %      | 8.0      | %      |              |   |   |   | 5.5               | %      |   |   |   |   |
| Europe, Middle East and Africa          |   | 63.9     |   | 60.9     |   |              |   |   |   | 51.9              |   |   |   |   |   |
| Other                                   |   | 1.7      |   | 3.3      |   |              |   |   |   | 4.3               |   |   |   |   |   |
| Total                                   |   | 73.2     | %      | 72.2     | %      |              |   |   |   | 61.7              | %      |   |   |   |   |

 

*Product and license fees*. In 2003, thedecline in revenues from product and license fees was primarily attributable tocontinued pressure on sales prices for our Unified Assurance products,especially for those products and applications for which there is a competitiveoffering or in highly competitive situations involving prospectivecustomers.  The sales price pressure wasmitigated somewhat by an increase in the number of Unified Assurance productimplementations of approximately 12% and an increase in the total number of Diagnosticsproducts sold of approximately 6%. Prices for our most basic GeoProbe systemgenerally decreased by approximately 10% to 15% in 2003. We anticipate that wewill continue to experience pricing pressure for our products, although to alesser extent than what we experienced in 2003. In 2002, the decline inrevenues from product and license fees was primarily attributable tosignificantly lower demand for our Diagnostics products, slightly lower levelsof business and sales price pressure for our Unified Assurance products.  We believe that these decreases wereattributable primarily to decreased capital spending by communications carriersand equipment manufacturers, which we believe was driven by their need toreduce capital and operating expenditures. In 2002, the total number of Diagnosticsproducts sold decreased by approximately 33% and we continued to experiencepressure on sales prices for our Unified Assurance products. In 2002, pricesfor our most basic GeoProbe system generally decreased by approximately 20% to30% from prices experienced in 2001.

 

*Services.* The increase in servicesrevenues in both 2003 and 2002 was primarily attributable to a larger installedbase of products with customers for which we provide product support services,offset by continued price pressure on prices for product supportcontracts.  The largest component of theincrease in our installed base of products is attributable to repeat businesswith existing customers, with a smaller component relating to new customers.  Going forward, we expect to sell additionalapplications to, or expand the footprint of our products with existingcustomers, and to add new customers, which should continue to increase ourinstalled base of products and corresponding services revenues; however, weexpect that continued pressure on prices may partially offset the effect ofthis anticipated increase in our installed base.

 

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*Concentration of revenues.* In both 2003and 2002, British Telecom accounted for approximately 21% of total revenues andDeutsche Telekom accounted for approximately 11% of total revenues. In 2001,revenues from Deutsche Telekom accounted for approximately 12% of totalrevenues. A large percentage of our revenues are typically derived from a smallnumber of customers, the specific composition of which varies from one quarterto the next.  On a quarterly basis, our10 largest customers for that period have typically accounted for approximately50% to 80% of total revenues for that quarter. In 2003, 26 different customersrepresented a top 10 customer, measured on a quarterly basis, compared to 23different customers in 2002.  On anannual basis, our top 10 customers accounted for approximately 60% of totalrevenues in 2003, approximately 57% of total revenues in 2002 and approximately56% of total revenues in 2001. We expect similar levels of concentration ofrevenues in 2004. If we were to lose one or more of our significant customers,our financial results could be harmed.

 

*International revenues.* International revenuesaccounted for approximately 73% of total revenues in 2003, approximately 72% oftotal revenues in 2002 and approximately 62% of total revenues in 2001. Sincethe introduction of our initial GeoProbe product in 1995, we have experiencedrelatively greater penetration of our Unified Assurance products in Europeversus other regions of the world. Variations in the percentage of totalrevenues derived from international markets may occur as a result of theeconomic conditions in the regions in which we operate and the concentration ofrevenues in a particular period from a small number of customers.  In 2004, we expect revenues frominternational markets to continue to represent the majority of our totalrevenues.

 

***Cost of Revenues andGross Margins***

 

The following table sets forth,for the periods indicated, a year-over-year comparison of the key components ofour cost of revenues and gross margins:

 

**Cost of Revenues**

 

|                       |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|----------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollars  in millions)** |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Product and license fees   |   | $        | 19.9   |     | $      | 26.7              |   | $      | (6.8   | )                 | (25    | )% | $ | 34.7 |   | $ | (8.0 | ) | (23 | )% |
| Services                   |   | 14.2     |   | 12.6     |   | 1.6               |   | 13     |   | 8.9               |   | 3.7 |   | 42 |   |
| Total cost of revenues     |   | $        | 34.1   |     | $      | 39.3              |   | $      | 5.2    |              | (13    | )% | $ | 43.6 |   | $ | (4.3 | ) | (10 | )% |
|                       |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Average headcount          |   | 123      |   | 123      |   |              |   |   |   | 128               |   |   |   |   |   |

 

**Gross Margin**

 

|                                           |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|------------------------------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollars  in millions)**                     |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Product and license fees                       |   | $        | 53.1   |     | $      | 47.9              |   | $      | 5.2    |              | 11     | % | $ | 49.4 |   | $ | (1.5 | ) | (3 | )% |
| Services                                       |   | 16.6     |   | 14.7     |   | 1.9               |   | 13     |   | 14.0              |   | 0.7 |   | 5 |   |
| Total gross margin                             |   | $        | 69.7   |     | $      | 62.6              |   | $      | 7.1    |              | 11     | % | $ | 63.4 |   | $ | (0.8 | ) | (1 | )% |
|                                           |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| **Gross margin  as a percentage of revenues:** |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Gross margin – total                      |   | 67       | %      | 61       | %      |              |   |   |   | 59                | %      |   |   |   |   |
| Gross margin – product and license fees   |   | 73       |   | 64       |   |              |   |   |   | 60                |   |   |   |   |   |
| Gross margin – services                   |   | 54       |   | 54       |   |              |   |   |   | 61                |   |   |   |   |   |

 

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*Product and license fees.* Cost of productand license fees consists primarily of hardware, third-party software,personnel and overhead expenses related to the integration, installation andconfiguration of our products. The decrease in the cost of product and licensefees in 2003 compared to 2002 is primarily driven by the relatively higher software-basedcontent of our product implementations. The major components of the decreases in absolute dollars and as apercentage of product and license fees revenues from 2003 to 2002 weredecreased hardware and third-party software costs of approximately $3.7million, decreased installation costs of $0.3 million and decreased excess orobsolete inventory costs of approximately $0.7 million. In 2003, we utilizedinventory previously identified as excess, which reduced our reserve for excessinventory by $0.3 million, compared to an increase to the reserve for excessinventory of $0.4 million in 2002. During 2002 compared to 2001, the decreases in both absolute dollars andas a percentage of product and license fees revenues resulted primarily fromdecreased hardware and third-party software costs, which were approximately$5.3 million lower than in 2001, and to a lesser extent, decreased installationcosts, including installation contract labor, which were approximately $1.0million lower than in 2001. The decrease in hardware costs is attributable to ahigher percentage of our GeoProbe product implementations during 2002 beingderived from expansions of existing systems or from the sales of softwareapplications than from new system implementations, which typically have ahigher hardware component. The decrease in absolute dollars in 2002 alsoreflects a reduction of $1.6 million in the amounts charged to cost of revenuesin 2001 for excess and obsolete inventory and canceled purchase commitments.

 

*Services.* Cost of services consists ofexpenses, primarily personnel costs, related to our product support, trainingand warranty activities. In 2003 compared to 2002, the increase in absolutedollars is attributable to increased efforts to support a larger installed baseof products and increased expenses related to customer support and systemsengineering. Historically, cost of services as a percentage of servicesrevenues has fluctuated as a result of the relative mix of product support andtraining activities during a specific period. We expect these fluctuations tocontinue into the foreseeable future. During the first quarter of 2002, we released a new version of GeoProbe,which resulted in increased support costs in 2002 compared to 2001.

 

***Operating Expenses***

 

*Research and Development Expenses*

 

The following table sets forth,for the periods indicated, a year-over-year comparison of the key components ofour research and development expenses.

 

|                       |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|----------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollars  in millions)** |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Research and development   |   | $        | 29.8   |     | $      | 29.8              |   | $      | — |              | — |   | $ | 39.3 |   | $ | (9.5 | ) | (24 | )% |
| Percent of total revenues  |   | 29       | %      | 29       | %      |              |   |   |   | 37                | %      |   |   |   |   |
| Average headcount          |   | 245      |   | 264      |   |              |   |   |   | 306               |   |   |   |   |   |
|                            |        |          |        |          |        |                   |        |        |        |                   |        |  |  |  |  |  |  |  |  |  |

 

Research and development expenses consist primarily ofpersonnel, contract labor and facilities expenses incurred by our research anddevelopment organization. The decreases in absolute dollars and as a percentageof total revenues in 2002 compared to 2001 were attributable to decreasedstaffing dedicated to research and development activities and, to a lesserextent, decreased use of third-party research and development services, whichwere $1.2 million lower in 2002 compared to 2001. The decrease in headcount wasprimarily attributable to discontinued research and development efforts withrespect to our VIATM softswitch offering in the second quarter of2001. We currently expect to slightly increase research and developmentheadcount during 2004.

 

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Software development costs are expensed as incurreduntil technological feasibility has been established, at which time subsequentcosts are permitted to be capitalized until the product is available forgeneral release to customers.  To date,either the establishment of technological feasibility of our products hassubstantially coincided with their general release, or costs incurredsubsequent to the achievement of technological feasibility have not beenmaterial.  As a result, softwaredevelopment costs qualifying for capitalization have been insignificant, and wehave not capitalized any software development costs.

 

*Sales and Marketing Expenses*

 

The following table sets forth,for the periods indicated, a year-over-year comparison of the key components ofour sales and marketing expenses.

 

*** ***

|                      |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|---------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollar in  millions)** |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Sales and marketing       |   | $        | 15.5   |     | $      | 16.5              |   | $      | (1.0   | )                 | (6     | )% | $ | 18.8 |   | $ | (2.3 | ) | (12 | )% |
| Percent of total revenues |   | 15       | %      | 16       | %      |              |   |   |   | 18                | %      |   |   |   |   |
| Average headcount         |   | 67       |   | 75       |   |              |   |   |   | 90                |   |   |   |   |   |
|                           |        |          |        |          |        |                   |        |        |        |                   |        |  |  |  |  |  |  |  |  |  |

 

Sales and marketing expenses consist primarily ofexpenses associated with personnel, including commissions from direct sales,travel, facilities and marketing, such as trade show and advertising expenses.The decreases in absolute dollars and as a percentage of total revenues in 2003compared to 2002 were primarily attributable to decreased staffing dedicated tosales and marketing activities. The decrease as a percentage of total revenuesin 2003 was also attributable in part to the increased level of revenues. Wecurrently expect to increase our sales and marketing headcount over the nextseveral quarters.  We anticipate thatsales and marketing expenses may fluctuate quarter to quarter due to seasonal spendingon tradeshows, other promotional activities and the level of direct salescommissions.  The decreases in absolutedollars and as a percentage of total revenues in 2002 compared to 2001 wereattributable to decreased staffing dedicated to sales and marketing activitiesand cost reduction efforts primarily related to advertising and travel.Advertising costs decreased $0.7 million and travel costs decreased $0.4million in 2002 compared to 2001.

 

*General and Administrative Expenses*

 

The following table sets forth,for the periods indicated, a year-over-year comparison of the key components ofour general and administrative expenses.

 

*** ***

|                       |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|----------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollars  in millions)** |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| General and administrative |   | $        | 9.2    |     | $      | 8.0               |   | $      | 1.2    |              | 15     | % | $ | 9.7 |   | $ | (1.7 | ) | (18 | )% |
| Percent of total revenues  |   | 9        | %      | 8        | %      |              |   |   |   | 9                 | %      |   |   |   |   |
| Average headcount          |   | 43       |   | 44       |   |              |   |   |   | 57                |   |   |   |   |   |
|                            |        |          |        |          |        |                   |        |        |        |                   |        |  |  |  |  |  |  |  |  |  |

 

General andadministrative expenses consist primarily of personnel, facilities andprofessional expenses of our finance, legal and executive departments. The increases in absolute dollars and as apercentage of revenues in 2003 compared to 2002 were attributable to increasedprofessional fees of approximately $0.5 million, primarily related to ourrepurchase of common stock in January 2003 and a secondary public stockoffering completed in October 2003.  Weexpect general and administrative expenses to remain flat during 2004 comparedto 2003.  The decreases inabsolute

 

23

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dollars and as a percentage of total revenues in 2002 compared to 2001were primarily attributable to decreased average headcount.

 

*Restructuring Costs*

 

In the quarter ended September 30, 2002, we recorded arestructuring charge of approximately $0.4 million related primarily to aworkforce reduction of approximately 35 employees. The reduction affected allareas of the company.  The chargeconsisted primarily of employee severance of approximately $0.3 million andprofessional fees and outplacement services of approximately $0.1 million.  At December 31, 2002, the balance of thesecosts that remained to be paid was approximately $0.1 million.  At December 31, 2003, substantially allcosts associated with this restructuring had been paid.

 

In May 2001, we announced our decision to refocus ourstrategy and streamline operations to reduce our cost structure in response tothe generally weakened economic environment and changing demand characteristicsin some of our markets.  As part of thisdecision, we discontinued all efforts with respect to our VIATMsoftswitch offering and reduced our workforce by approximately 115employees.  The reduction affected allareas of the company. We recorded a restructuring charge for the three monthsended June 30, 2001 of approximately $1.7 million, which consisted of employeeseverance of approximately $1.1 million, professional fees and outplacementservices of approximately $0.3 million and the write-off of assets related tothe VIA softswitch of approximately $0.3 million. In the fourth quarter of2001, we decreased this charge by $0.1 million due to changes in previousestimates related to professional fees. In the third quarter of 2002, we decreased this charge by $0.2 milliondue to changes in previous estimates related to professional fees andemployee-related obligations. All costs associated with this restructuring werepaid by December 31, 2002.

 

We recorded arestructuring charge for the three months ended March 31, 2001 of approximately$0.5 million related primarily to a workforce reduction of approximately 40employees. The reduction affected all areas of the company.  The charge consisted primarily of employeeseverance, professional fees and outplacement services.  In the fourth quarter of 2001, we decreasedthis charge by $0.1 million due to changes in previous estimates related toseverance and professional fees.  Allcosts associated with this workforce reduction were paid by December 31, 2002.

 

***Other Income***

 

The following table sets forth,for the periods indicated, a year-over-year comparison of the key components ofour other income:

 

|                                                      |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|-----------------------------------------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollars  in millions)**                                |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Investment income                                         |   | $        | 1.4    |     | $      | 2.6               |   | $      | (1.2   | )                 | (46    | )% | $ | 5.6 |   | $ | (3.0 | ) | (54 | )% |
| Foreign currency translation gain (loss)                  |   | (0.2     | )      | 0.2      |   | (0.4              | )      | 200    |   | (0.3              | )      | 0.5 |   | 166 |   |
| Total other income                                        |   | $        | 1.2    |     | $      | 2.8               |   | $      | (1.6   | )                 | (57    | )% | $ | 5.3 |   | $ | (2.5 | ) | (47 | )% |
|                                                      |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Rate of return on average cash and short-term investments |   | 0.8      | %      | 1.5      | %      |              |   |   |   | 3.8               | %      |   |   |   |   |

 

Other income consists primarily of interest incomeearned on our cash and cash equivalents and investment income earned on ourinvestment in U.S. Treasury bills, partially offset by foreign

 

24

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currency translation adjustments and losses on the disposal of assets.The decrease in 2003 compared to 2002 was primarily attributable to the overalldecrease in interest rates received on our investments, lower average cashbalances resulting from our repurchase of common stock in January 2003 andforeign currency translation adjustments. The decrease in 2002 compared to 2001was primarily attributable to the overall decrease in interest rates receivedon our investments. Foreign currency translation gains or losses primarilyarise from translation adjustments for our international operations, includingthe United Kingdom and German sales and support organizations and, to a lesserextent, to the small percentage of our business denominated in non-U.S.currencies.  To date, we have notengaged in hedging activities for our international operations or our non-U.S.dollar business.

 

***Provision for IncomeTaxes***

 

The following table sets forth, for the periodsindicated, a year-over-year comparison of our provision for income taxes:

 

|                         |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|------------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollars  in millions)**   |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Income tax expense (benefit) |   | $        | 4.8    |     | $      | 3.2               |   | $      | 1.6    |              | 50     | % | $ | (1.3 | ) | $ | 4.5 |   | 346 | % |
|                         |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Effective tax rate           |   | 28.9     | %      | 29.4     | %      |              |   |   |   | (117.6            | )%     |   |   |   |   |
|                              |        |          |        |          |        |                   |        |        |        |                   |        |  |  |  |  |  |  |  |  |  |

 

In 2003 and 2002, the effective tax rate differed fromthe 35% statutory corporate tax rate primarily due to the effect of theextraterritorial income exclusion and research and development tax credits.

 

Our financial statements reflect net deferred taxassets of $1.8 million as of December 31, 2003, comprised of deductibletemporary differences.  We haveconcluded that it is more likely than not that the net deferred tax assets willbe realized based on the scheduling of deferred tax amounts and projectedtaxable income, although we cannot assure you that such assets will berealized.  The amount of the netdeferred tax assets actually realized could vary if there are differences inthe timing or amount of future reversals of existing deferred tax amounts orchanges in the actual amounts of future taxable income.

 

***Net Income***

 

The following table sets forth,for the periods indicated, a year-over-year comparison of our net income:

 

|                       |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|----------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollars  in millions)** |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Net income                 |   | $        | 11.7   |     | $      | 7.6               |   | $      | 4.1    |              | 54     | % | $ | 0.2 |   | $ | 7.4 |   | 3,700 | % |
| Percent of total revenues  |   | 11.3     | %      | 7.5      | %      |              |   |   |   | 0.2               | %      |   |   |   |   |
|                            |        |          |        |          |        |                   |        |        |        |                   |        |  |  |  |  |  |  |  |  |  |

 

Net income in absolute dollarsand as a percentage of total revenues has increased primarily due to thesignificant increase in gross margins and our measures taken to controloperating expenses.

 

25

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**Liquidity and Capital Resources**

 

The following table sets forth,for the periods indicated, a year-over year comparison of key components of ourliquidity and capital resources:

 

|                                                                           |   |     |   |     |   | **2003 vs. 2002** |   |   |   | **2002 vs. 2001** |   |
|--------------------------------------------------------------------------------|--------|----------|--------|----------|--------|-------------------|--------|--------|--------|-------------------|--------|
| **(dollars  in millions)**                                                     |   | **2003** |   | **2002** |   | **$**             |   | **%**  |   | **2001**          |   | **$** |   | **%** |   |
| Operating cash flows                                                           |   | $        | 21.3   |     | $      | 34.9              |   | $      | (13.6  | )                 | (39    | )% | $ | 28.9 |   | $ | 6.0 |   | 21 | % |
| Investing cash flows                                                           |   | (59.0    | )      | (2.3     | )      | (56.7             | )      | (2,465 | )      | (8.5              | )      | 6.2 |   | 73 |   |
| Financing cash flows                                                           |   | (32.9    | )      | 1.6      |   | (34.5             | )      | (2,156 | )      | 3.0               |   | (1.4 | ) | (47 | ) |
|                                                                           |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Capital expenditures                                                           |   | 4.0      |   | 2.3      |   | 1.7               |   | 74     |   | 8.5               |   | (6.2 | ) | (73 | ) |
|                                                                           |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Cash and cash equivalents                                                      |   | 118.5    |   | 189.1    |   | (70.6             | )      | (37    | )      | 154.9             |   | 34.2 |   | 22 |   |
| Short-term investments                                                         |   | 55.0     |   | —   |   | 55.0              |   | — |   | —            |   | — |   | — |   |
| Accounts receivable, net                                                       |   | 10.9     |   | 10.2     |   | 0.7               |   | 7      |   | 14.9              |   | (4.7 | ) | (32 | ) |
| Inventories                                                                    |   | 7.9      |   | 7.5      |   | 0.4               |   | 5      |   | 12.5              |   | (5.0 | ) | (40 | ) |
| Working capital                                                                |   | 165.5    |   | 182.5    |   | (17.0             | )      | 9      |   | 170.1             |   | 12.4 |   | 7 |   |
|                                                                           |   |     |   |     |   |              |   |   |   |              |   |   |   |   |   |
| Days sales outstanding in accounts receivable, including unbilled  receivables |   | 37.2     |   | 38.1     |   |              |   |   |   | 59.4              |   |   |   |   |   |
| Inventory turns                                                                |   | 4.5      |   | 4.6      |   |              |   |   |   | 2.8               |   |   |   |   |   |
|                                                                                |        |          |        |          |        |                   |        |        |        |                   |        |  |  |  |  |  |  |  |  |  |

 

Since our inception, we havefunded our operations and met our capital expenditure requirements primarilythrough cash flows from operations and to a lesser extent during our initialyears of operations through bank borrowings. Cash decreased in 2003 primarilydue to our investment in U.S. Treasury bills with maturities greater than 90days, but less than one year, which are classified as short-term investments.The decreases in cash and working capital are also attributable to our fundingof a privately-negotiated transaction that closed on January 21, 2003, underwhich we repurchased 8,969,984 restricted shares of common stock from MarkWeinzierl, one of our founders, for an aggregate cash purchase price ofapproximately $35.4 million.

 

Operating cash flows in 2003decreased primarily due to changes in trade accounts receivable and  inventories, offset by increased levels ofincome.  In 2003, accounts receivableincreased slightly due to increased levels of business and inventories increaseddue to new product releases and higher deferred cost levels. Operating cashflows in 2002 increased primarily due to increased levels of net income andchanges in our operating accounts, most significantly decreased inventory andtrade accounts receivable. Inventory levels decreased because of our proactivemeasures to use material on-hand and purchase new materials only when necessaryto support current business levels. Accounts receivable balances decreased due to slightly lower levels ofbusiness and enhanced collection efforts.

 

Cash used in investingactivities was $59.0 million in 2003, $2.3 million in 2002 and $8.5 million in2001. In 2003, we used $55.0 million to purchase short-term investments thatyield a slightly higher return on investment than our cash equivalents and weused $4.0 million to purchase property and equipment.  Net cash used in investing activities in 2002 and 2001 wasrelated to purchases of property and equipment. We reduced our levels ofpurchases of property and equipment in 2002 to conserve cash given the tighteconomic environment.

 

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Cash used in financingactivities was $32.9 million in 2003 compared to cash provided by financingactivities of $1.6 million in 2002 and $3.0 million in 2001. In 2003, weused approximately $35.4 million to repurchase 8,969,984 restricted shares ofcommon stock in a privately-negotiated transaction. Net cash provided by financing activities in each year was related toproceeds from the issuance of stock under our stock option and employee stockpurchase plans.

 

We may in the future pursueacquisitions of businesses, products or technologies, or enter into jointventure arrangements, that could complement or expand our business and product offerings.  Any material acquisition or joint venturecould result in a decrease in our working capital depending on the amount,timing and nature of the consideration to be paid.  From time to time we also consider various other alternatives toutilize any cash and cash equivalents that exceed our working capitalrequirements, including payment of cash dividends, additional stock repurchasesor other similar transactions.

 

At December 31, 2003, we had no long-term debt. We believe thatour current cash balances and expected future cash flows will be sufficient tomeet our anticipated cash needs for working capital, capital expenditures andother activities for at least the next 12 months and possibly much longer.Beyond that, if current sources are not sufficient to meet our needs, we mayseek additional equity or debt financing. In addition, any material acquisitionof other businesses, products or technologies or material investments in jointventures could require us to obtain additional equity or debt financing. Therecan be no assurance that additional financing would be available on acceptableterms, if at all.

 

**Off-Balance Sheet Arrangements and Contractual Obligations**

 

It is not our usual businesspractice to enter into off-balance sheet arrangements, except for off-balancesheet arrangements related to inventory purchase commitments and operatinglease commitments, as disclosed in the table of contractual obligationsbelow.  Moreover, it is not our normalpolicy to issue guarantees to third parties.

 

We are obligated to make futurepayments under various contracts, including non-cancelable inventory purchasecommitments and the operating leases for our corporate office facility and ourfacilities near the cities of London, England; Frankfurt, Germany; Paris,France and Milan, Italy. The following table summarizes our contractual cashobligations as of December 31, 2003 (in thousands):

 
|                 |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **2008** |   | **Thereafter** |   |
|----------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|
| Purchase commitments |   | $        | 4,595  |     | $      | —   |   | $        | — |     | $      | —         |   | $ | — |   | $ | — |   |
| Operating leases     |   | 6,097    |   | 6,248    |   | 6,348    |   | 6,348    |   | 6,348    |   | 11,566         |   |
| Total                |   | $        | 10,692 |     | $      | 6,248    |   | $        | 6,348  |     | $      | 6,348          |   | $ | 6,348 |   | $ | 11,566 |   |

 

We currently have no material commitments for capitalexpenditures.  In 2004, we expect capital expenditures to be slightly higherthan levels experienced in 2003.

 

**Related Party Transactions**

 

In October 2003, we completed anunderwritten secondary offering of our common stock.  All shares were offered by two of our founders, Elie S. Akilian,our president, chief executive officer and director, and Samuel S. Simonian,the chairman of our board of directors. Since we did not issue any new shares, we did not receive any of theproceeds from the sale of common stock. We effected the offering pursuant to a demand made by the selling shareholdersin accordance with the rights granted to them under the registration rightsagreement dated July 23, 1998.  We paidall of the expenses of the offering incurred by us and certain fees andexpenses of the selling stockholders, excluding

 

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underwritten discounts and commissions.  Total expenses of approximately $0.4 millionfor accounting, legal and professional fees are included on our 2003 financialstatements.

 

Effective September 30, 2003, weamended and extended the July 23, 1998 registration rights agreement.  Under the new agreement, Messrs. Akilian andSimonian will each be entitled to demand, prior to October 1, 2008, up to tworegistrations of firm-commitment underwritten offerings of their commonstock.  The selling stockholder orstockholders will be required to pay all of their and our expenses incurred inconnection with any demand-based registrations.

 

On January 21, 2003, werepurchased in a privately-negotiated transaction 8,969,984 restricted sharesof our common stock from Mark A. Weinzierl, one of our founders and a member ofour board of directors, for an aggregate cash purchase price of approximately$35.4 million. We funded the transaction with available cash.  The shares repurchased representedapproximately 19% of our total shares outstanding immediately prior to thetransaction.  Effective as of theclosing of the transaction, Mr. Weinzierl resigned from our board of directors.

 

Epygi Technologies, Ltd., an entity controlled bySamuel S. Simonian, one of our founders and chairman of our board, currentlyperforms development services for us pursuant to a consulting agreement forwhich it is paid a monthly fee per full-time programmer plus reimbursement ofreasonable business expenses.  Weexpensed $0.3 million for these services in 2003, $0.9 million in 2002 and $1.4million in 2001.

 

**Accounting Policies**

 

In preparing our consolidatedfinancial statements in conformity with U.S. generally accepted accountingprinciples, or GAAP, we use certain estimates and assumptions that affect thereported amounts and related disclosures and may vary from actual results.  We consider the following accountingpolicies as those most important to the portrayal of our financial conditionand those that require the most judgment or the greatest use of estimates.  Although we believe that our estimates andassumptions are reasonable, actual results may differ, and such differencescould be significant to our financial results.

 

***Revenue Recognition***

 

*General.*We derive revenues primarily fromproduct and license fees as well as services, which include training, warrantyand product support services. The majority of the contracts for our UnifiedAssurance products contain multiple billing milestones, such as contract award,shipment, installation, ready for acceptance and acceptance, not all of whichare associated with revenue recognition. Except as otherwise discussed below,revenues from product and license fees are recognized in the period that we havecompleted all hardware manufacturing and/or software development to contractualspecifications, factory testing has been completed, the product has beenshipped to the customer, the fee is fixed and determinable and collection ofthe fee is considered probable.  When wehave significant obligations subsequent to shipment, such as installation andsystem integration, revenues are recognized when there are no significantunfulfilled obligations.  Revenues fromarrangements that include significant acceptance terms and/or provisions arerecognized when acceptance has occurred. Revenues from our Diagnostics products are typically recognized whentitle and risk of loss pass to the customer, which typically occurs at shipment.  For these products, we typically have nosignificant obligations subsequent to shipment.  If a significant obligation were to exist, we would defer revenuerecognition until such obligation was satisfied.  All shipping costs are included in cost of revenues in ourconsolidated statements of income.

 

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*Multiple element arrangements.*Contractsfor our Unified Assurance products involve multiple deliverables.  We determine the fair value of each of thecontract deliverables using vendor-specific objective evidence, or VSOE.  VSOE for each element is based on the pricefor which we would sell the element on a stand-alone basis. We offer ourcustomers product support services, which include the correction of softwareproblems, hardware replacement, telephone access to our technical personnel andthe right to receive unspecified product updates, upgrades and enhancements,when and if they become available. Revenues from these services, including post-contract support includedin initial licensing fees, are recognized ratably over the service period.  Post-contract support included in theinitial licensing fee are allocated from the total contract amount based on thefair value of these services determined using VSOE.  Revenues from other services, such as training, are recognizedwhen the services have been completed. If we determine that we do not have VSOEon an undelivered element of an arrangement, we will not recognize revenueuntil all elements of the arrangement are delivered.  This occurrence could materially impact our financial resultsbecause of the significant dollar amount of many of our contracts and thesignificant portion of total revenues that a single contract may represent inany particular period.

 

***Trade AccountsReceivable and Allowance for Doubtful Accounts***

 

A large portion of our revenues and accountsreceivable are attributable to our carrier customers in the communicationsindustry and, to a lesser extent, to our equipment manufacturer customers whosupply equipment into the communications industry. Our trade accountsreceivable balance is recorded net of allowances for amounts not expected to becollected from our customers. Because our accounts receivable are usuallyunsecured, we periodically evaluate the collectibility of our accounts based ona combination of factors, including a particular customer’s ability to pay andthe age of the receivables. To evaluate a specific customer’s ability to pay,we analyze the customer’s payment history, if any, financial statements or otherinformation provided by the customer, or third-party credit analysis reports orother publicly-available information. In cases where the evidence suggests acustomer may not be able to satisfy its obligations to us, we set up a specificreserve in an amount we determine appropriate for the perceived risk. Most ofour contracts include multiple payment milestones, some of which occur inadvance of revenue recognition, which mitigates our risk both in terms ofcollectibility and adjustments to recorded revenue. We have not historicallyexperienced significant losses on uncollectible accounts and our allowance hasbeen less than 5% of recorded receivables.

 

***Inventory Reserves***

 

Inventories are recorded net ofallowances for unsalable or obsolete raw materials, work-in-process andfinished goods.  We evaluate on aquarterly basis the status of our inventory to ensure the amount recorded inour financial statements reflects the lower of our cost or the value we expect toreceive when we sell the inventory.  Thisestimate is based on several factors, including the condition and salability ofour inventory and the forecasted demand for the particular productsincorporating inventory components. Based on current backlog, expected orders and other expected demand, weforecast the usage of current stock.  Werecord reserves for obsolete and slow-moving parts of up to 100% for excessparts with insufficient demand or obsolete parts.  Amounts in work-in-process and finished goods inventory typicallyrelate to firm orders and, therefore, are not subject to obsolescence risk. Ifmarket conditions deteriorate or the expected future demand for our productsotherwise decreases, or if changes in our business strategy reduce our need forthese components, our estimate of the carrying value of our inventory could bereduced by a material amount.

 

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***Income Taxes***

 

In the preparation of our provision for income taxesand determination of whether deferred tax assets will be realized in full or inpart, we must estimate several factors. When it is more likely than not that all or some portion of the deferredtax asset will not be realized, a valuation allowance must be established forthe amount of the deferred tax assets that is determined not to be realizable.As of December 31, 2003 and 2002, a valuation for deferred tax assets was notdeemed necessary.  If the facts orfinancial results on which our estimates are based were to change, therebyimpacting the likelihood of realizing the deferred tax assets, judgment wouldhave to be applied to determine the amount of valuation allowance required inany given period.  Additionally, ourincome tax returns are subject to review and examination in the variousjurisdictions in which we operate.  Weare currently not aware of any material issues that have been raised by taxingjurisdictions, and management believes that all income tax issues which may beraised as a result of such reviews and examinations in the future will beresolved with no material impact on our financial position or future results ofoperations.  However, in the event therewas an assessment by any of these jurisdictions, it could impact our taxprovision.

 

**RecentAccounting Pronouncements**

 

In July 2002, the Financial Accounting StandardsBoard, or FASB, issued SFAS No. 146, *Accounting for Costs Associated with Exit or DisposalActivities*. This statement nullifies Emerging Issues Task Force, orEITF Issue No. 94-3, *Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring)*. The standard requires companies to recognize costs associated with exitor disposal activities when they are incurred rather than at the date ofcommitment to an exit or disposal plan. This statement is applicable to exit or disposal activities initiatedafter December 31, 2002.  The adoptionof this standard did not have an effect on our financial position or results ofoperations.

 

**RiskFactors**

 

*You should carefully consider therisks described below before making an investment decision regarding our commonstock. The risks and uncertainties described below are not the only ones facingus. Additional risks and uncertainties that we do not presently know or that wecurrently deem immaterial may also impair our business operations. Thisdocument is qualified in its entirety by these risk factors.*

 

*If any of the following risks actually occur, they couldmaterially harm our business, financial condition or results of operations. Inthat case, the market price of our common stock could decline.*

 

***Our quarterly financial results fluctuate and are difficultto predict.***

 

Our quarterly financial results have variedsignificantly in the past and are likely to vary significantly from quarter toquarter in the future based on a number of factors, many of which are outsideof our control. As a result, you should not rely on our results of operationsduring any particular quarter as an indication of our future performance in anyquarterly period or fiscal year. The factors that could affect our quarterlyfinancial results include:

 

•                  the size,timing, pricing structure and other terms of specific orders by our customers;

 

•                  the timing ofthe delivery to and the installation and acceptance of our products by ourcustomers;

 

•                  the timing ofour development and introduction of new products or applications;

 

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•                  the relative mixof product and license fees and services fees included in our revenues;

 

•                  the relative mixof hardware- and software-related revenues in our total revenues;

 

•                  the relativepercentages of products sold through our direct and indirect sales channels;

 

•                  the timing andlevel of our investments in research and development activities, and the timingand magnitude of our sales and marketing and general and administrativeexpenses;

 

•                  changes in, andour ability to implement, our strategy; and

 

•                  other risksdescribed below.

 

A significant portion of our operating expenses,including rent and salaries, is largely fixed in nature. Accordingly, ifrevenues are below expectations, our financial results are likely to beadversely and disproportionately affected because these operating expenses arenot variable in the short term and cannot be quickly reduced to respond tounanticipated decreases in revenues.

 

Our financial results are also likely to fluctuate dueto factors that impact our current and prospective customers. Expenditures bycustomers tend to vary in cycles that reflect overall economic conditions,individual budgeting and buying patterns and, in some cases, the ability ofsome of our customers to obtain the financing they require to make capitalexpenditures. Our business has been harmed by a soft economy, and we would befurther harmed by a decline in the economic prospects of our customers or theeconomy in general. This harm would be exacerbated by a decline in the economicprospects of our current and prospective customers in Europe, as revenues fromthis region have historically represented the majority of our total revenues.In many cases, these adverse economic conditions have altered current andprospective customers’ capital spending priorities or budget cycles, which haveextended our sales cycle. These adverse effects could continue and could impactour customers’ ability to meet their financial obligations to us. Our businessalso could be harmed by changes in customer spending patterns reflectingindustry trends. For example, customer budgetary constraints have contributedto downward sales price pressure on some of our products and on renewals ofproduct support agreements for our Unified Assurance products, which haveadversely affected our revenues.  Inaddition, our financial results historically have been influenced by seasonalfluctuations, with orders tending to be strongest in the fourth quarter of eachyear and orders in our first quarter tending to be lower than the levelsachieved in the preceding quarter. We believe that this seasonality has beendue in large part to the capital appropriation practices of many of ourcustomers.

 

As a result of all of the foregoing, we cannot assureyou that our revenues will grow or remain stable in future periods or that wewill remain profitable. In addition, in some future quarters our financialresults may be below the expectations of public market analysts or investors.In such event, the market price of our common stock would likely fall.

 

***Reduced communications spending, or consolidations or bankruptciesin the communications industry, could harm our business, financial conditionand results of operations.***

 

We have derived substantially all of our revenues fromsales of products and related services to the communications industry. Sinceearly 2001, we and a number of other companies have been impacted by reducedspending by communications carriers and equipment manufacturers, and spendinglevels for future periods are difficult to predict.  Our business, financial condition and results of operations couldbe materially harmed in the event that economic or business conditions in ourindustry do not continue to improve. We could also be impacted in the eventthat there are consolidations of our current customers, which could result inthe displacement of our products by a competitor’s products preferred by theother party to the consolidation, or bankruptcies of our current or prospectivecustomers, which could result in reduced revenues or significant write-offs ofuncollectible accounts receivable. Additionally, decreases in spending oftencause delays in sales and installations and could cause cancellations ofcurrent or planned projects, any of which could harm our financial results in aparticular period.

 

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***Our financial results could be materially harmed if demandfor our new products is less than we anticipate or the performance of ourproducts falls below the levels required by our customers.***

 

A key component of our strategy is the ability to successfullydevelop, introduce and market new Unified Assurance and Diagnostics productsand applications. Although we have obtained input from our customers andpotential customers regarding our development and product strategy, we havemade certain assumptions as to the needs of our customers and the features,functionality and performance expected by them. Our current or prospectivecustomers may not order these new products and applications.

 

Also, purchase decisions regarding certain of ourUnified Assurance products and applications may be made by individuals withinorganizations with which we have no significant existing relationships, such ascustomer service, sales and marketing, or information technology departments.We may not be successful in developing the relationships necessary to sellcertain of our Unified Assurance products and applications.

 

In addition to the service quality management featuresof our Unified Assurance products, communications carriers also require systemsto manage the quality of service of the other aspects of their customer-relatedactivities, such as billing, trouble ticket management and inventorycontrol.  As a result, in certain casesa communications carrier may seek the functionality that we offer as acomponent of a broader service quality management system, addressing all ofthese quality management needs, rather than through specific offerings frommultiple vendors.  In such cases, theopportunity to provide these systems may only be offered to our competitors whohave a broader product offering or to system integrators who would develop suchfunctionality internally or purchase it from other vendors.  We cannot assure you that we would beconsidered by such system integrators to provide our products as part of theoverall service quality management system.

 

***Our revenues are highly concentrated among a small number ofcustomers.***

 

A large percentage of our revenues are typicallyderived from a small number of customers, and we expect this trend to continue.For example, in 2003 approximately 60% of our revenues were derived from theten largest customers in the period, with British Telecom and Deutsche Telekom,on a combined basis, accounting for approximately 32% of total revenues.Although the customer make-up of our largest projects varies from quarter toquarter, a small number of significant repeat customers frequently account fora significant portion of our revenues in a given period. If we were to lose oneor more of our significant repeat customers, our financial results could beharmed. Additionally, if one or more of these significant repeat customersexperiences adverse conditions in its industry or operations, including theimpact of any economic downturn or reduction in communications spending, thesecustomers may not be able to meet their ongoing financial obligations to us orpurchase additional products.

 

***Changes or delays in the implementation or customeracceptance of our products could harm our financial results.***

 

Revenues for our Unified Assurance products, whichaccounted for the majority of our total revenues in the year ended December 31,2003, are typically recognized upon the completion of system installation orcustomer acceptance. Delays caused by us or our customers in the commencementor completion of scheduled product installations and acceptance testing mayoccur from time to time due to site-readiness delays, the often comprehensiveprocesses for testing and acceptance required by certain of our customers,insufficient personnel on the part of us or our customers to complete aproject, the lengthening of implementation schedules due to the introduction ofnew features or applications, or other issues. Because a significant portion ofour total revenues on

 

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a quarterly basis is derived from a small number of customer projects,product installation delays could materially harm our financial results for aparticular period. With respect to contracts providing for a significantpayment or performance milestone tied to customer acceptance or allowingcustomer return, termination or similar rights prior to acceptance, wegenerally do not recognize revenue until acceptance is achieved. For newproducts, we typically recognize revenue initially upon acceptance. As aresult, in cases where the recognition of revenue is tied to customeracceptance, the failure to obtain acceptance or delayed acceptance could harmour financial results for a particular period. Additionally, we may be subjectto penalties or other customer claims for a failure to meet contractuallyagreed upon milestones or deadlines.

 

***The sales cycle for our products is long, which could harmour quarterly financial results.***

 

Sales of our Unified Assurance products, which since1998 have accounted for the majority of our total revenues, are madepredominantly to large communications carriers and involve significant capitalexpenditures as well as lengthy sales cycles and implementation processes.Sales to this type of customer generally require an extensive sales effortthroughout the customer’s organization and final approval by an executiveofficer or other senior-level approval. We expend substantial funds andmanagement effort pursuing these sales. Additionally, potential customers oftenmaintain comprehensive processes for internal approval, contracting andprocurement, which may cause potential sales to be delayed or foregone. As aresult of these and other factors, the sales cycle for our products is long,historically ranging from six to 18 months for our Unified Assurance products(excluding the cycle for subsequent applications and enhancements, which varieswidely) and averaging three months for occasional, large sales of ourDiagnostics products. Accordingly, our ability to forecast the timing andamount of specific sales is limited, and the deferral or loss of one or moresignificant sales could materially harm our financial results in a particularquarter, especially if there are significant sales and marketing expenses associatedwith any deferred or lost sales.

 

***Competition is intense, may intensify and could result inincreased downward pricing pressure, reduced margins and the loss of marketshare.***

 

Competition for all of our products is intense, isexpected to continue and in some cases may intensify. We compete principallywith a number of U.S. and international suppliers that vary in size and in thescope and breadth of the products and services offered. We compete to a lesserextent with systems developed internally by current and prospective customers.Certain of our competitors have, in relation to us, longer operating histories,larger installed customer bases, longer-standing relationships with customers,greater name recognition and significantly greater financial, technical,marketing, customer service, public relations, distribution and otherresources. As a result, these competitors may be able to more quickly developor adapt to new or emerging technologies and changes in customer requirements,or devote greater resources to the development, promotion and sale of theirproducts. Additionally, it is possible that new competitors or alliances amongcompetitors could emerge and rapidly acquire significant market share.Increased competition could result in increased downward pricing pressure,reduced margins and the loss of market share. We continue to experiencepressure on sales prices for our GeoProbe and Orion products, especially forthose applications for which there is a competitive offering, or in highlycompetitive situations involving prospective customers.

 

***Our business depends on retaining our existing keypersonnel.***

 

Our business depends to a significant extent upon thecontinued service and performance of a relatively small number of key seniormanagers, technical personnel and sales and marketing personnel, none of whomare bound by an agreement to remain in our employ. The loss of any

 

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existing key personnel, or the inability to attract, motivate and retainadditional key personnel, could harm our business, financial condition andresults of operations.

 

***We may be unable to adapt to rapid technological change andevolving customer requirements.***

 

The introduction by others of products involvingsuperior technologies or the evolution of alternative technologies or newindustry protocol standards could render our existing products, as well asproducts currently under development, obsolete and unsalable. We believe thatour future success will depend in part upon our ability, on a timely andcost-effective basis, to continue to:

 

•                  develop andintroduce new products or applications for the communications market;

 

•                  enhance ourUnified Assurance and Diagnostics products;

 

•                  keep pace withevolving industry protocol standards, next-generation technologies and changingcustomer needs; and

 

•                  achieve broadmarket acceptance for our products.

 

We cannot assure you that we will achieve theseobjectives.

 

Over the long term, we expect carrier spending fortraditional networks to continue to decrease, which requires that we continueto develop products and applications for networks based on emergingnext-generation wireless and packet-based technologies and standards. We maynot successfully develop or acquire additional competitive products for theseemerging technologies and standards.

 

Products as complex as those currently underdevelopment by us frequently are subject to delays, and we cannot assure youthat we will not encounter difficulties, such as the inability to assign asufficient number of qualified technical personnel to key projects or otherunanticipated causes, that could delay or prevent the successful and timelydevelopment, introduction and marketing of these potential new products. Evenif such potential new products are developed and introduced, we cannot assureyou that they will achieve any significant degree of market acceptance. Inaddition, our products are implemented with our purpose-specific hardwareplatform and certain third-party hardware and software. We cannot assure youthat we will be able to design and manufacture, or procure from third parties,the hardware and software necessary to successfully implement our new productsand applications.

 

***A majority of our revenues have historically come from ourinternational customers, and, as a result, our business may be harmed bypolitical and economic conditions in foreign markets and the challengesassociated with operating internationally.***

 

Historically, revenues from international markets haverepresented the majority of our total revenues, and international revenues as apercentage of total revenues have increased in recent years. We expect revenuesfrom international markets to continue to represent the majority of our totalrevenues for the foreseeable future. International business activities involvecertain risks, including:

 

•                  management ofour geographically dispersed operations;

 

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•                  longer salescycles in certain countries, especially on initial entry into a newgeographical market;

 

•                  greaterdifficulty in evaluating a customer’s ability to pay, longer accountsreceivable payment cycles and greater difficulty in the collection of past-dueaccounts;

 

•                  general economicconditions in each country;

 

•                  currencycontrols and exchange rate fluctuations;

 

•                  challengesassociated with operating in diverse cultural and legal environments;

 

•                  seasonalreductions in business activity specific to certain markets;

 

•                  loss ofrevenues, property and equipment from expropriation, nationalization, war,insurrection, terrorism and other political risks;

 

•                  foreign taxesand the overlap of different tax structures, including modifications to theU.S. tax code as a result of international trade regulations;

 

•                  greaterdifficulty in safeguarding intellectual property;

 

•                  import andexport licensing requirements and other trade restrictions;

 

•                  involuntaryrenegotiation of contracts with foreign governments and communicationscarriers; and

 

•                  existence oradoption of laws and regulations affecting the operation and taxation of ourbusiness and the general business climate for foreign companies.

 

***We may be unable to produce sufficient quantities of ourproducts because we obtain various key components from sole and limited sourcesuppliers. If we are unable to obtain these components, or if the prices ofthese components increase, we could be unable to ship our products in a timelymanner or our product costs could be materially impacted.***

 

We could experience delays or reductions in productshipments or increases in product costs if we are unable to obtain sufficientkey components as required or to develop alternative sources if and as requiredin the future. Currently, our products utilize certain components that areavailable from only one or a limited number of suppliers. While alternativesuppliers have been identified for a variety of key components, thosealternative sources have not been qualified or activated by us. Ourqualification process could be lengthy, and we cannot assure you thatadditional sources would become available to us on a timely basis, or if suchsources were to become available, that the components would be comparable inprice and quality to our current components. We generally do not executelong-term supply agreements with our suppliers and, in the case of manycomponents, make our purchases with purchase orders on an “as-needed basis.”Some of the components our products utilize require long order lead-times, incertain cases up to nine months. Other components that currently are readilyavailable may become difficult to obtain in the future. Our failure to ordersufficient quantities of these components in advance of product deliverydeadlines could prevent us from adequately responding to unanticipatedincreases in customer orders. In the past, we have experienced delays in thereceipt of a variety of our key components, which have resulted in delays inproduct deliveries. In addition, the cost of various key components of ourproducts has fluctuated significantly in the past based on supply and demandfactors. Significant changes in supply and demand characteristics in the futurecould cause the cost of various components to increase, which could adverselyimpact our product costs.

 

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***Key components used in our products may become obsolete. Ifwe are unable to find and design in replacement parts, we may be unable to shipour products in sufficient quantities.***

 

From time to time,components used in our products are declared obsolete and no longer produced byour suppliers. Historically, we have typically received adequate notice fromthese suppliers so that we may procure quantities of these parts sufficient toallow us time to find and design new parts into our products; however, wecannot assure you that we will always be provided adequate notice. If we arenot given adequate notice, we may be unable to produce sufficient quantities ofour products to satisfy demand. Also, we cannot assure you that replacementparts will be readily available or that we will be able to design new partsinto our products on a timely basis at a reasonable cost. If we are not able toproduce sufficient quantities of our products, our financial results could beharmed.

 

***Our inventory may become obsolete or unusable.***

 

From time to time, wemake advance purchases of various component parts in relatively largequantities to ensure that we have an adequate and readily available supply. Ourfailure to accurately project our needs for these components and the demand forour products that incorporate them, or changes in our business strategy thatreduce our need for these components, could result in these components becomingobsolete prior to their intended use or otherwise unusable in our business,which in turn could result in significant write-offs of inventory.

 

***We rely in part on third-party subcontractors in themanufacture and development of our products. Our ability to sell products toour customers could be impaired if these subcontractors do not meet theircommitments to us.***

 

Any disruption in ourrelationships with third-party subcontractors and our inability to developalternative sources if and as required in the future could result in delays orreductions in product shipments or increases in product costs. We relyexclusively upon third-party subcontractors to manufacture our subassemblies,and we have retained, from time to time, third-party design services in thelayout of circuit boards. We also frequently subcontract the development ofspecific features or enhancements for our products. Our reliance on third-partysubcontractors involves a number of risks, including the potential absence ofadequate capacity, the unavailability of or interruption in access to variousprocess technologies, and reduced control over product quality, deliveryschedules, manufacturing yields and costs.

 

***We rely upon software licensed from third parties. If we areunable to maintain these software licenses on commercially reasonable terms,our business, financial condition and results of operations could be harmed.***

 

We rely upon softwarethat we license from Oracle Corporation, Cognos Incorporated and other thirdparties, including software that is integrated with our internally-developedsoftware and used in our products to perform key functions. In certain cases,we are unable to obtain long-term pricing commitments for this software. Theinability to maintain any software licenses on commercially reasonable termscould result in shipment delays or reductions until equivalent software couldbe developed or licensed and integrated into our products. Additionally, thepresence of defects or errors in this software could result in claims againstus or damage to our reputation and business, recourse for which might not beavailable against the related licensors.

 

***Our strategy may require that we pursue acquisitions, jointventures or other business relationships. We may not successfully develop these relationships to support our strategyor we***

 

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***may not receive the intended benefits of any futureacquisitions, joint ventures or other business relationships.***

 

Although in the past wehave developed or licensed substantially all of our product technologies, someof the technologies, features and functionalities we are contemplating or whichmay be required to meet the perceived needs of our customers and potentialcustomers may be more effectively and timely obtained through the acquisitionof businesses, products or technologies from third-parties, or theestablishment of joint venture, strategic partnership or other arrangementswith firms already possessing such technologies.  We may also pursue such acquisitions or arrangements to expandour business, addressable markets and product offerings.  There can be no assurance that suitable andinterested candidates for these activities will be identified, or if they areidentified that any such acquisition or arrangement can be consummated on termsacceptable to us.

 

The negotiation ofpotential acquisitions or strategic relationships, as well as the integrationof an acquired or jointly developed business, technology or product, couldcause diversion of management’s time and resources. Future acquisitions andstrategic relationships by us could result in potentially dilutive issuances ofequity securities, a material reduction in cash reserves, the incurrence ofdebt and contingent liabilities, research and development write-offs and other acquisition-relatedexpenses. We cannot assure you that any acquisition or joint venture will besuccessfully integrated with our operations. If we were to pursue any suchacquisition or strategic relationship, we may not receive the intended benefitsof the acquisition or strategic relationship.

 

***We may be accused of infringing the proprietary rights ofothers, which could subject us to costly and time-consuming litigation.***

 

The communicationsindustry is characterized by the existence of a large number of patents andfrequent allegations of patent infringement. We have received, and may receivein the future, notices from holders of patents that raise issues as to possibleinfringement by our products. As the number of competitive products increasesand the functionality of these products further overlaps, we believe that wemay become increasingly subject to allegations of infringement. Questions ofinfringement and the validity of patents in the field of communicationssignaling technologies involve highly technical and subjective analyses. Patentholders may initiate legal proceedings in the future against us, and if anyproceedings are initiated, we may not be successful in defending ourselves. Anyclaim or proceeding could be time consuming and expensive to defend or resolve,result in substantial diversion of management resources, cause product shipmentdelays, or force us to enter into royalty or license agreements rather thandispute the merits of any such claim made or proceeding initiated against us. Anysuch royalty or license agreements may not be available on terms acceptable tous, if at all.

 

***Our limited ability or failure to protect our intellectualproperty may materially harm our ability to compete.***

 

Our continued success isdependent in part upon our proprietary technology. To protect our proprietarytechnology, we rely on a combination of technical innovation, trade secret,copyright and trademark laws, non-disclosure agreements and, to a lesserextent, patents, each of which affords only limited protection. In addition,the laws of some foreign countries do not protect our proprietary rights in ourproducts to the same extent as do the laws of the U.S. Despite the measurestaken by us, it may be possible for a third party to copy or otherwise obtainand use our proprietary technology and information without authorization.Policing unauthorized use of our products is difficult, and litigation may benecessary in the future to enforce our intellectual property rights. Anylitigation could be time consuming and expensive to prosecute or resolve,result in substantial diversion of management attention and resources, andmaterially harm our business, financial condition and

 

37

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results of operations. Wemay not be successful in protecting our proprietary technology, or ourproprietary rights may not provide us a meaningful competitive advantage.

 

***We may face potential liability for product defects.***

 

Products as complex asours may contain undetected defects or errors, especially when first introducedor as enhancements are released, that, despite our testing, are not discovereduntil after a product has been installed and used by customers. Defects orerrors could result in delayed market acceptance of the product, claims againstus or damage to our reputation and business. We generally include provisions inour agreements with customers that are intended to limit our exposure topotential liability for damages arising out of defects or errors in ourproducts. However, the nature and extent of these limitations vary fromagreement to agreement, and it is possible that these limitations may not beeffective as a result of unfavorable judicial decisions or current or futurelaws enacted in one or more of the jurisdictions in which we do business.Although we have not experienced any product liability suits to date, the saleand support of our products entail the risk of these claims. We carry insurancethat mitigates our risk associated with certain product liability claims, butthe policy is subject to coverage limits, various exceptions and options tocancel prior to term and may not be sufficient to cover all claims. Any productliability claim brought against us, regardless of its merit, could result inmaterial expense to us, diversion of management attention and resources, anddamage to our business reputation and our ability to retain existing customersor attract new customers.

 

***Our business and reputation could suffer if we do notprevent security breaches.***

 

We have included securityfeatures in some of our products that are intended to protect the privacy andintegrity of customer data. Despite the existence of these security features,our products may be vulnerable to breaches in security due to unknown defectsin the security mechanisms, as well as vulnerabilities inherent in theoperating system or hardware platform on which the product runs and/or thenetworks linked to that platform. Security vulnerabilities, regardless oforigin, could jeopardize the security of information stored in and transmittedthrough the computer systems of our customers. Any security problem may requiresignificant capital expenditures to solve and could materially harm ourreputation and product acceptance.

 

***Our two largest stockholders own approximately 40% of ourcommon stock, which gives them effective control over the management andaffairs of our company and could delay or prevent a change of control.***

 

Two of our founders,Samuel S. Simonian, chairman of our board, and Elie S. Akilian, our presidentand chief executive officer and a director, collectively beneficially ownapproximately 40% of the outstanding shares of our common stock. Consequently,if these individuals were to act together, they could effectively control theoutcome of all matters submitted for stockholder action, including the electionof our board of directors and the approval of significant corporatetransactions. They also effectively control the management and affairs of ourcompany, which could have the effect of delaying or preventing a change incontrol of our company. In addition, as two of the five members of our board ofdirectors, Messrs. Simonian and Akilian have significant influence in directingthe actions taken by our board.

 

***We have previously adopted anti-takeover defenses that coulddelay or prevent an acquisition of our company.***

 

Our certificate ofincorporation and bylaws and Delaware law contain provisions that may have theeffect of discouraging, delaying or preventing a change in control of ourcompany or unsolicited

 

38

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acquisition proposalsthat a stockholder may consider favorable. For example, we have a classifiedboard of directors with staggered, three-year terms, our stockholders areunable to take action by written consent, our stockholders are limited in theirability to make proposals at stockholder meetings, and our board of directorsis empowered to issue blank-check preferred stock without any need to obtainstockholder approval.

 

***Volatility in our stock price could result in claims againstus.***

 

The market price of ourcommon stock has been, and is likely to continue to be, highly volatile. In theperiods listed below, the market price of our common stock has ranged asfollows:

 

|            |   | **High** |   | **Low** |   |
|-----------------|--------|----------|--------|---------|--------|
| **2003**        |   |     |   |    |   |
| Fourth  Quarter |   | $        | 14.60  |    | $      | 11.09 |   |
| Third  Quarter  |   | 16.00    |   | 9.76    |   |
| Second  Quarter |   | 10.50    |   | 5.87    |   |
| First  Quarter  |   | 8.25     |   | 5.78    |   |
|            |   |     |   |    |   |
| **2002**        |   |     |   |    |   |
| Fourth  Quarter |   | $        | 6.98   |    | $      | 4.15 |   |
| Third  Quarter  |   | 6.68     |   | 4.00    |   |
| Second  Quarter |   | 10.30    |   | 5.71    |   |
| First  Quarter  |   | 11.05    |   | 7.91    |   |

 

Our stock price may besignificantly affected by factors such as:

 

•                  variationsin our results of operations;

 

•                  changesin our business strategy;

 

•                  futuresales of our common stock, particularly by institutional investors with largeholdings and by our founders;

 

•                  theannouncement of technological innovations or new products by us, ourcompetitors or others;

 

•                  marketanalysts’ estimates of our performance, our customers’ or competitors’ performanceor the performance of the communications industry in general;

 

•                  thefinancial and other announcements made by us, our competitors or customers;

 

•                  generalmarket and economic conditions; and

 

•                  equitymarket conditions and industry-specific equity market trends.

 

The public markets haveexperienced significant volatility that has particularly affected the marketprices of securities of many technology and communications companies forreasons that have often been unrelated to financial results. This volatilityhas and may in the future materially harm the market price of our common stockas well as our visibility and credibility in our markets.

 

Additionally, in thepast, securities class action litigation often has been brought against acompany following periods of volatility in the market price of its commonstock. We may be the target of similar litigation in the future. Securitieslitigation could result in substantial costs and diversion of managementattention and resources.

 

39

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**Item 7A****.  Quantitative and Qualitative DisclosuresAbout Market Risk.**

 

Historically, we havebeen exposed to immaterial levels of market risk and have not beensignificantly exposed to fluctuations in currency exchange rates. In both 2003and 2002, approximately 3% of total revenues was denominated in currenciesother than the U.S. dollar, principally the Euro.  Prior to 2002, less than 1% of total revenues had beendenominated in currencies other than the U.S. dollar. In future periods, webelieve a greater portion of total revenues could be denominated in currenciesother than the U.S. dollar, thereby increasing our exposure to exchange rategains and losses on non-U.S. currency transactions.  Currently, we do not engage in hedging activities for ournon-U.S. dollar business.

 

Our internationalsubsidiaries operate in currencies other than the U.S. dollar, which results intranslation gains and losses; however, the U.S. dollar is the functionalcurrency of all our subsidiaries. Currently, we do not engage in hedging activities for our internationaloperations.  However, we may engage inhedging activities in the future.

 

Ourinternational business is subject to the typical risks of any internationalbusiness, including, but not limited to, the risks described in Item 7 –“Management’s Discussion and Analysis of Financial Condition and Results ofOperations – Risk Factors.” Accordingly, our future results could be materially harmed by the actualoccurrence of any of these or other risks.

 

Currently,our cash is invested in bank deposits and money market funds denominated inU.S. dollars. We account for these investments in accordance with SFAS 115, *Accountingfor Certain Investments in Debt and Equity Securities*. These cashequivalents are treated as available-for-sale under SFAS 115.  The carrying value of these cash equivalentsapproximates fair market value.  We alsoinvest in U.S. Treasury bills.  U.S.Treasury bills with maturities that are less than 90 days are classified ascash equivalents.  U.S Treasury billswith maturities that are more than 90 days but less than one year areclassified as short-term investments. All U.S. Treasury bills are classified as held to maturity and carriedat amortized cost.  Our investments aresubject to interest rate risk, which is the risk that our financial conditionand results of operations could be adversely affected due to movements ininterest rates.  Assuming current levelsof cash, if the per annum rate of interest earned on our invested cash were tochange by 50 basis points, or 0.5%, our investment income would be impacted byapproximately $0.6 million on an annual basis.

 

**Item 8****.  Financial Statements and Supplementary Data.**

 

See ourconsolidated financial statements included in Part IV, Item 15.

 

**Item 9****.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure.**

 

None.

 

**Item 9A****. Controlsand Procedures.**

 

(a)          Evaluation ofdisclosure controls and procedures. We maintain disclosure controls andprocedures designed to provide reasonable assurance that information requiredto be disclosed in the periodic reports we file with the SEC is recorded,processed, summarized and reported within the time periods specified in therules of the SEC.  We carried out anevaluation as of December 31, 2003, under the supervision and theparticipation of our management, including our chief executive officer andchief financial officer, of the design and operation of these disclosurecontrols and procedures pursuant to Exchange Act Rule 13a-15(c).  Based upon that evaluation,

 

40

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our chief executiveofficer and chief financial officer concluded that our disclosure controls andprocedures are effective in timely alerting them to material informationrelating to the company (including our consolidated subsidiaries) required tobe included in our periodic SEC filings.

 

(b)         Changes in internalcontrols. There was no change in internal control over financial reportingthat occurred during the three months ended December 31, 2003 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PARTIII**

 

**Item 10****.  Directors and Executive Officers of theregistrant.**

 

Information called for byItem 10 will be included under the captions **“Proposal 1, Election of Directors,”****“ExecutiveCompensation,”****“Section 16(a) Beneficial Ownership ReportingCompliance”** and **“Code of Business Conduct and Ethics”**inour Proxy Statement for the 2004 Annual Meeting of Stockholders, whichinformation is incorporated in this Annual Report by reference.

 

**Item 11****.  Executive Compensation.**

 

Information called for byItem 11 will be included under the caption **“Executive Compensation”** in our Proxy Statementfor the 2004 Annual Meeting of Stockholders, which information is incorporatedin this Annual Report by reference.

 

**Item 12****.  Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters.**

 

Information called for byItem 12 will be included under the captions **“Principal Stockholders”** and **“Proposal 2,Amendment of 1998 Employee Stock Purchase Plan”** in our ProxyStatement for the 2004 Annual Meeting of Stockholders, which information isincorporated in this Annual Report by reference.

 

**Item 13****.  Certain Relationships and RelatedTransactions.**

 

Information called for byItem 13 will be included under the caption **“Certain Transactions with Management”** inour Proxy Statement for the 2004 Annual Meeting of Stockholders, which informationis incorporated in this Annual Report by reference.

 

**Item 14****.  Principal Accountant Fees and Services.**

 

Information called for byItem 14 will be included under the caption **“Proposal 3, Ratification of Selection of IndependentAuditors”** in our Proxy Statement for the 2004 Annual Meeting ofStockholders, which information is incorporated in this Annual Report byreference.

 

41

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**PARTIV**

 

**Item 15****.  Exhibits, Financial StatementSchedule and Reports on Form 8-K.**

 

(a)          (1)          Consolidated Financial Statements

 

The followingconsolidated financial statements are filed as part of this Annual Report onthe pages indicated:

 
| Report of Independent  Auditors                                                                                  |   |
|------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated Balance Sheets  as of December 31, 2003 and 2002                                               |   |
| Consolidated  Statements of Operations for the years ended December 31, 2003, 2002 and  2001                |   |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31,  2003, 2002 and 2001 |   |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2003, 2002 and  2001                |   |
| Notes to  Consolidated Financial Statements                                                                      |   |

 

(2)          Consolidated FinancialStatement Schedule

 
| Report  of Independent Auditors                                                                                       |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|
| Schedule II  – Valuation and Qualifying Accounts for the years ended December 31,  2003, 2002 and 2001 |   |

 

Schedules otherthan those listed are omitted as the required information is inapplicable orthe information is presented in the consolidated financial statements orrelated notes.

 

(3)          Exhibits

 

The following exhibitsare incorporated in this Annual Report by reference or are filed with thisreport as indicated below.  The exhibitsfiled with this report have been included only with the copy filed with theSEC.  Copies of exhibits will befurnished, upon request, subject to payment of a reasonable fee to reimburse usfor our reproduction costs.

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                   |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                              |
| 3.1                 |   | Certificate  of Incorporation (1)                                                                                                                                 |
| 3.2                 |   | Amended  and Restated Bylaws (1)                                                                                                                                  |
| 4.1                 |   | Specimen  Common Stock certificate (1)                                                                                                                            |
| 4.2                 |   | See  Exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation and  Bylaws of the registrant defining the rights of holders of common stock         |
| 10.1                |   | Form  of Indemnification Agreement between the registrant and each of its directors  and executive officers (11)                                                  |
| 10.2                |   | Amended  and Restated Registration Rights Agreement dated as of September 30,  2003 by and among the registrant, Samuel S. Simonian and Elie S. Akilian (12) |
| 10.3                |   | Inet  Technologies, Inc. 1998 Employee Stock Purchase Plan (8)                                                                                                    |
| 10.4                |   | First  Amendment to the Inet Technologies, Inc. 1998 Employee Stock Purchase Plan  (4)                                                                            |
| 10.5                |   | Second  Amendment to the Inet Technologies, Inc. 1998 Employee Stock Purchase Plan  (8)                                                                           |
| 10.6                |   | Lease  dated as of January 27, 2000 by and among Collins Crossing, LTD. and                                                                                  |

 

42

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|   |   | the  registrant (5)                                                                                                                                                            |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7   |   | Lease  Amendment No. 1 dated March 31, 2000 by and among Collins Crossing, LTD.  and the registrant (6)                                                                   |
| 10.8   |   | Lease  Amendment No. 2 dated June 1, 2000 by and among Collins Crossing, LTD.  and the registrant (6)                                                                     |
| 10.9   |   | Letter  Agreement dated June 2, 2000 between the registrant and Mark H. Kleinman  (7) (10)                                                                                |
| 10.10  |   | Inet  Technologies, Inc. 1998 Stock Option/Stock Issuance Plan (1) (7)                                                                                                         |
| 10.11  |   | Stock  Repurchase Agreement dated January 16, 2003 between the registrant and  Mark A. Weinzierl (2)                                                                      |
| 10.12  |   | Consulting Agreement  dated April 1, 2002 between Epygi Technologies, Ltd. and the registrant  (9)                                                                        |
| 21.1   |   | Subsidiaries  of the registrant (3)                                                                                                                                            |
| 23.1   |   | Consent  of Ernst & Young LLP (3)                                                                                                                                          |
| 24.1   |   | Power  of Attorney, pursuant to which amendments to this report may be filed, is  included on the signature page contained in Part IV hereof                                   |
| 31.1   |   | Certification  of Elie S. Akilian, President and Chief Executive Officer of the Company, as  adopted pursuant to  Section 302  of the Sarbanes-Oxley Act of 2002 (3) |
| 31.2   |   | Certification  of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the  Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 (3)  |
| 32.1   |   | Certification  of Elie S. Akilian, President and Chief Executive Officer of the Company, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  (3)       |
| 32.2   |   | Certification  of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the  Company, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 (3)  |

 

----

| (1)  |   | Previously  filed as an exhibit to the registrant’s Registration Statement on Form S-1  (Reg. No. 333-59753) and incorporated herein by reference.                     |
|------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  |   | Previously  filed as an exhibit to the registrant’s Current Report on Form 8-K dated  January 21, 2003 and incorporated herein by reference.                      |
| (3)  |   | Filed  herewith.                                                                                                                                                            |
| (4)  |   | Previously  filed as an exhibit to the registrant’s Quarterly Report on Form 10-Q for the  quarter ended June 30, 2001 and incorporated herein by reference.      |
| (5)  |   | Previously  filed as an exhibit to the registrant’s Annual Report on Form 10-K for the  year ended December 31, 1999 and incorporated herein by reference.        |
| (6)  |   | Previously  filed as an exhibit to the registrant’s Annual Report on Form 10-K for the  year ended December 31, 2000 and incorporated herein by reference.        |
| (7)  |   | Management  contract or compensatory plan or arrangement.                                                                                                                   |
| (8)  |   | Previously  filed as an exhibit to the registrant’s Quarterly Report on Form 10-Q for the  quarter ended June 30, 2002 and incorporated herein by reference.      |
| (9)  |   | Previously  filed as an exhibit to the registrant’s Quarterly Report on Form 10-Q for the  quarter ended March 31, 2002 and incorporated herein by reference.     |
| (10) |   | Previously  filed as an exhibit to the registrant’s Annual Report on Form 10-K for the  year ended December 31, 2001 and incorporated herein by reference.        |
| (11) |   | Previously  filed as an exhibit to the registrant’s Quarterly Report on Form 10-Q for the  quarter ended June 30, 2003 and incorporated herein by reference.      |
| (12) |   | Previously  filed as an exhibit to the registrant’s Quarterly Report on Form 10-Q for the  quarter ended September 30, 2003 and incorporated herein by reference. |

 

43

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(b)                                 Reportson Form 8-K

 

During the three monthsended December 31, 2003 we furnished one Report on Form 8-K.  Information regarding each item reported onis listed below.

 
| **Date Filed or  Furnished** |   | **Item No.** |   | **Description**                                                                                                           |
|------------------------------|--------|--------------|--------|---------------------------------------------------------------------------------------------------------------------------|
| October 21, 2003        |   | Item 12      |   | On October 21,  2003, we announced our results of operations for our fiscal quarter ended  September 30, 2003.* |

 

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*This furnished Form 8-Kis not to be deemed filed or incorporated by reference into any filing.

 

44

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|   |                         | INET TECHNOLOGIES, INC. |
|--------|------------------------------|-------------------------|
|   |                         |                    |   |
|   |                         |                    |   |
|   | Date: January 30,  2004 | By:                     | /s/ Elie S. Akilian |   |
|   |                         |                    | Elie  S. Akilian |
|   |                         |                    | President,  Chief Executive Officer  and Director |
|   |                         |                    | (Principal  executive officer) |

 

POWER OF ATTORNEY

 

Each person whosesignature appears below hereby authorizes and constitutes Mark H. Kleinman andJeffrey A. Kupp, and each of them singly, his true and lawful attorneys-in-factwith full power of substitution and resubstitution, for him and in his name,place and stead, in any and all capacities to sign and file any and allamendments to this report with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, and hehereby ratifies and confirms all that said attorneys-in-fact or any of them, ortheir substitutes, may lawfully do or cause to be done by virtue hereof.

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 

 
|   | Date: January 30,  2004 | By:    | /s/ Samuel S. Simonian                            |   |
|--------|------------------------------|--------|---------------------------------------------------|--------|
|   |                         |   | Samuel S.  Simonian                               |
|   |                         |   | Chairman of the  Board                            |
|   |                         |   |                                              |
|   |                         |   |                                              |
|   | Date: January 30,  2004 | By:    | /s/ Elie S. Akilian                               |   |
|   |                         |   | Elie S. Akilian                                   |
|   |                         |   | President,  Chief Executive Officer  and Director |
|   |                         |   | (Principal  executive officer)                    |
|   |                         |   |                                              |
|   |                         |   |                                              |
|   | Date: January 30,  2004 | By:    | /s/ Jeffrey A. Kupp                               |   |
|   |                         |   | Jeffrey A. Kupp                                   |
|   |                         |   | Vice President  and Chief Financial Officer       |
|   |                         |   | (Principal  financial and accounting officer)     |
|   |                         |   |                                              |
|   |                         |   |                                              |
|   | Date: January 30,  2004 | By:    | /s/ James R. Adams                                |   |
|   |                         |   | James R. Adams                                    |
|   |                         |   | Director                                          |
|   |                         |   |                                              |   |
|   |                         |   |                                              |   |
|   | Date: January 30,  2004 | By:    | /s/ George H. Heilmeier                           |   |
|   |                         |   | George H.  Heilmeier                              |
|   |                         |   | Director                                          |
|   |                         |   |                                              |
|   |                         |   |                                              |
|   | Date: January 30,  2004 | By:    | /s/ M. Samuel Self                                |   |
|   |                         |   | M. Samuel Self                                    |
|   |                         |   | Director                                          |

 

45

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**REPORT OF INDEPENDENT AUDITORS**

 

 

TheBoard of DirectorsInet Technologies, Inc.

 

Wehave audited the accompanying consolidated balance sheets of Inet Technologies,Inc., (the Company), as of December 31, 2003 and 2002, and the relatedconsolidated statements of operations, stockholders’ equity and cash flows foreach of the three years in the period ended December 31, 2003. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

Weconducted our audits in accordance with auditing standards generally acceptedin the United States. Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Inet Technologies,Inc. at December 31, 2003 and 2002, and the consolidated results of itsoperations and its cash flows for each of the three years in the period endedDecember 31, 2003, in conformity with accounting principles generally acceptedin the United States.

 

 

Dallas,Texas

January 26,2004

 

F-1

----

 

**INETTECHNOLOGIES, INC.****CONSOLIDATEDBALANCE SHEETS**

(In thousands, except sharedata)

 
|                                                                                                                                      |   | **December 31,** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|------------|
|                                                                                                                                      |   | **2003**              |       | **2002** |   |
|                                                                                                                                      |   |                  |       |   |   |
| **ASSETS**                                                                                                                                |   |                  | ** ** |   | ** ** |
|                                                                                                                                      |   |                  |       |   |   |
| Current assets:                                                                                                                           |   |                  |       |   |   |
| Cash and cash equivalents                                                                                                                 |   | $                     | 118,527    |   | $ | 189,076 |   |
| Short-term investments                                                                                                                    |   | 55,034                |       | — |   |
| Trade accounts receivable, net of allowance for  doubtful accounts  of $514 at  December 31, 2003 and $484 at December 31, 2002 |   | 10,870                |       | 10,211 |   |
| Unbilled receivables                                                                                                                      |   | 146                   |       | 155 |   |
| Inventories                                                                                                                               |   | 7,924                 |       | 7,458 |   |
| Deferred income taxes                                                                                                                     |   | 1,628                 |       | 850 |   |
| Other current assets                                                                                                                      |   | 5,055                 |       | 4,909 |   |
| Total current assets                                                                                                                      |   | 199,184               |       | 212,659 |   |
| Property and equipment, net                                                                                                               |   | 11,330                |       | 15,215 |   |
| Deferred income taxes                                                                                                                     |   | 217                   |       | — |   |
| Other assets                                                                                                                              |   | 613                   |       | 300 |   |
| Total assets                                                                                                                              |   | $                     | 211,344    |   | $ | 228,174 |   |
|                                                                                                                                      |   |                  |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                            |   |                  |       |   |   |
|                                                                                                                                      |   |                  |       |   |   |
| Current liabilities:                                                                                                                      |   |                  |       |   |   |
| Accounts payable                                                                                                                          |   | $                     | 1,919      |   | $ | 1,078 |   |
| Income taxes payable                                                                                                                      |   | 2,408                 |       | 1,792 |   |
| Accrued compensation and benefits                                                                                                         |   | 4,115                 |       | 4,113 |   |
| Deferred revenues                                                                                                                         |   | 21,554                |       | 18,323 |   |
| Other accrued liabilities                                                                                                                 |   | 3,724                 |       | 4,894 |   |
| Total current liabilities                                                                                                                 |   | 33,720                |       | 30,200 |   |
| Deferred tax liabilities                                                                                                                  |   | —                |       | 18 |   |
| Commitments and contingencies                                                                                                             |   |                  |       |   |   |
| Stockholders’ equity:                                                                                                                |   |                  |       |   |   |
| Preferred stock, $.001 par value:                                                                                                         |   |                  |       |   |   |
| Authorized shares — 25,000,000  Issued shares — None                                                                            |   | —                |       | — |   |
| Common stock, $.001 par value:                                                                                                            |   |                  |       |   |   |
| Authorized shares — 175,000,000  Issued shares — 47,159,643 at December 31, 2003 and 47,157,543 at  December 31, 2002 |   | 47                    |       | 47 |   |
| Additional paid-in capital                                                                                                                |   | 77,866                |       | 75,075 |   |
| Unearned stock compensation                                                                                                               |   | (2,610                | )          | (407 | ) |
| Retained earnings                                                                                                                         |   | 134,932               |       | 123,241 |   |
| Treasury stock, 8,240,060 common shares at  December 31, 2003  and no common  shares at December 31, 2002, at cost              |   | (32,611               | )          | — |   |
| Total stockholders’ equity                                                                                                           |   | 177,624               |       | 197,956 |   |
| Total liabilities and stockholders’ equity                                                                                           |   | $                     | 211,344    |   | $ | 228,174 |   |

 

See accompanying notes to consolidated financial statements.

 

F-2

----

 

**INET TECHNOLOGIES, INC.CONSOLIDATED STATEMENTS OFOPERATIONS**(In thousands, except pershare data)

 
|                                            |   | **Years Ended December 31,** |       |
|-------------------------------------------------|--------|-----------------------------------|------------|
|                                            |   | **2003**                          |       | **2002** |   | **2001** |   |
|                                            |   |                              | ** ** |   | ** ** |   | ** ** |
| Revenues:                                       |   |                              |       |   |   |   |   |
| Product and license fees                        |   | $                                 | 73,012     |   | $ | 74,605 |   | $ | 84,109 |   |
| Services                                        |   | 30,807                            |       | 27,281 |   | 22,906 |   |
| Total revenues                                  |   | 103,819                           |       | 101,886 |   | 107,015 |   |
|                                            |   |                              |       |   |   |   |   |
| Cost of revenues:                               |   |                              | ** ** |   | ** ** |   | ** ** |
| Product and license fees                        |   | 19,907                            |       | 26,705 |   | 34,748 |   |
| Services                                        |   | 14,219                            |       | 12,620 |   | 8,851 |   |
| Total cost of revenues                          |   | 34,126                            |       | 39,325 |   | 43,599 |   |
|                                            |   |                              |       |   |   |   |   |
| Gross profit                                    |   | 69,693                            |       | 62,561 |   | 63,416 |   |
| Operating expenses:                             |   |                              |       |   |   |   |   |
| Research and development                        |   | 29,789                            |       | 29,820 |   | 39,332 |   |
| Sales and marketing                             |   | 15,526                            |       | 16,507 |   | 18,771 |   |
| General and administrative                      |   | 9,167                             |       | 7,982 |   | 9,656 |   |
| Restructuring costs                             |   | —                            |       | 224 |   | 2,048 |   |
|                                            |   | 54,482                            |       | 54,533 |   | 69,807 |   |
| Income (loss) from operations                   |   | 15,211                            |       | 8,028 |   | (6,391 | ) |
| Other income (expense):                         |   |                              |       |   |   |   |   |
| Interest income                                 |   | 1,411                             |       | 2,591 |   | 5,579 |   |
| Other income (expense)                          |   | (181                              | )          | 163 |   | (285 | ) |
|                                            |   | 1,230                             |       | 2,754 |   | 5,294 |   |
| Income (loss) before provision for income taxes |   | 16,441                            |       | 10,782 |   | (1,097 | ) |
| Provision (benefit) for income taxes            |   | 4,750                             |       | 3,173 |   | (1,290 | ) |
| Net income                                      |   | $                                 | 11,691     |   | $ | 7,609 |   | $ | 193 |   |
|                                            |   |                              |       |   |   |   |   |
| Earnings per common share:                      |   |                              |       |   |   |   |   |
| Basic                                           |   | $                                 | 0.30       |   | $ | 0.16 |   | $ | 0.00 |   |
| Diluted                                         |   | $                                 | 0.30       |   | $ | 0.16 |   | $ | 0.00 |   |
|                                            |   |                              |       |   |   |   |   |
| Weighted-average shares outstanding:            |   |                              |       |   |   |   |   |
| Basic                                           |   | 39,059                            |       | 46,964 |   | 46,633 |   |
| Diluted                                         |   | 39,517                            |       | 47,084 |   | 47,087 |   |

 

See accompanying notes to consolidated financial statements.

 

F-3

----

 

**INETTECHNOLOGIES, INC.**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

(In thousands, except share data)

 
|                                                                                                           |               |       |       |   |       | **Additional  Paid-in  Capital** |       | **Unearned  Stock  Compensation** |       | **Retained  Earnings** |       |      |       |    |       | **Total  Stockholders’  Equity** |       |
|----------------------------------------------------------------------------------------------------------------|--------------------|------------|------------|--------|------------|----------------------------------|------------|-----------------------------------|------------|------------------------|------------|-----------|------------|---------|------------|---------------------------------------|------------|
| **Common Stock**                                                                                               | **Treasury Stock** |
| **Shares**                                                                                                     |               | **Amount** | **Shares** |   | **Amount** |
|                                                                                                           |               |       | ** ** |   | ** ** |                             | ** ** |                              | ** ** |                   | ** ** |      | ** ** |    | ** ** |                                  | ** ** |
| Balance at December 31,  2000                                                                             |               | 46,319,633 |       | $      | 46         |                             | $          | 69,935                            |       | $                      | —     |      | $          | 115,439 |       | —                                |       | $ | — |   | $ | 185,420 |   |
| Issuance of common stock  under employee stock option and stock purchase plans                                 |               | 437,376    |       | 1      |       | 2,869                            |       | —                            |       | —                 |       | —    |       | —  |       | 2,870                                 |       |
| Net income                                                                                                     |               | —     |       | — |       | —                           |       | —                            |       | 193                    |       | —    |       | —  |       | 193                                   |       |
| Balance at December 31,  2001                                                                             |               | 46,757,009 |       | 47     |       | 72,804                           |       | —                            |       | 115,632                |       | —    |       | —  |       | 188,483                               |       |
| Issuance of restricted stock                                                                                   |               | 84,000     |       | — |       | 425                              |       | (425                              | )          | —                 |       | —    |       | —  |       | —                                |       |
| Amortization of restricted  stock  awards                                                                 |               | —     |       | — |       | —                           |       | 18                                |       | —                 |       | —    |       | —  |       | 18                                    |       |
| Issuance of common stock  under employee stock option and stock purchase plans, including tax benefit  of $242 |               | 316,534    |       | — |       | 1,846                            |       | —                            |       | —                 |       | —    |       | —  |       | 1,846                                 |       |
| Net income                                                                                                     |               | —     |       | — |       | —                           |       | —                            |       | 7,609                  |       | —    |       | —  |       | 7,609                                 |       |
| Balance at December 31,  2002                                                                             |               | 47,157,543 |       | 47     |       | 75,075                           |       | (407                              | )          | 123,241                |       | —    |       | —  |       | 197,956                               |       |
| Repurchase of common stock                                                                                     |               | —     |       | — |       | —                           |       | —                            |       | —                 |       | 9,001,274 |       | (35,644 | )          | (35,644                               | )          |
| Issuance of restricted stock                                                                                   |               | —     |       | — |       | 1,788                            |       | (2,550                            | )          | —                 |       | (193,000  | )          | 762     |       | —                                |       |
| Amortization of restricted  stock  awards                                                                 |               | —     |       | — |       | —                           |       | 347                               |       | —                 |       | —    |       | —  |       | 347                                   |       |
| Issuance of common stock  under employee stock option and stock purchase plans, including tax benefit  of $527 |               | 2,100      |       | — |       | 1,003                            |       | —                            |       | —                 |       | (568,214  | )          | 2,271   |       | 3,274                                 |       |
| Net income                                                                                                     |               | —     |       | — |       | —                           |       | —                            |       | 11,691                 |       | —    |       | —  |       | 11,691                                |       |
| Balance at December 31,  2003                                                                             |               | 47,159,643 |       | $      | 47         |                             | $          | 77,866                            |       | $                      | (2,610     | )         | $          | 134,932 |       | 8,240,060                             |       | $ | (32,611 | ) | $ | 177,624 |   |

 

See accompanying notes to consolidated financial statements.

 

F-4

----

 

**INETTECHNOLOGIES, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(In thousands)

 
|                                                                                                                    |   | **Years Ended December 31,** |       |
|-------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                                                    |   | **2003**                          |       | **2002** |   | **2001** |   |
|                                                                                                                    |   |                              | ** ** |   | ** ** |   | ** ** |
| **Cash flows from operating activities:**                                                                               |   |                              |       |   |   |   |   |
| Net income                                                                                                              |   | $                                 | 11,691     |   | $ | 7,609 |   | $ | 193 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:                                      |   |                              |       |   |   |   |   |
| Depreciation and amortization                                                                                           |   | 6,867                             |       | 7,078 |   | 7,875 |   |
| Amortization of purchase discount on investments                                                                        |   | (35                               | )          | — |   | — |   |
| Loss on sale or disposal of assets                                                                                      |   | 4                                 |       | 10 |   | 326 |   |
| Deferred income taxes (benefits)                                                                                        |   | (1,013                            | )          | 1,294 |   | (948 | ) |
| Stock compensation                                                                                                      |   | 347                               |       | 18 |   | — |   |
| Change in operating assets and liabilities:                                                                             |   |                              |       |   |   |   |   |
| (Increase) decrease in trade accounts receivable                                                                        |   | (659                              | )          | 4,723 |   | 32,700 |   |
| (Increase) decrease in unbilled receivables                                                                             |   | 9                                 |       | 1,800 |   | (30 | ) |
| (Increase) decrease in inventories                                                                                      |   | (466                              | )          | 4,996 |   | (3,073 | ) |
| Decrease in income taxes receivable                                                                                     |   | —                            |       | 615 |   | 11,422 |   |
| (Increase) decrease in other assets                                                                                     |   | (459                              | )          | 539 |   | (2,154 | ) |
| Increase (decrease) in accounts payable                                                                                 |   | 841                               |       | 140 |   | (3,691 | ) |
| Increase in income taxes payable                                                                                        |   | 1,143                             |       | 2,034 |   | — |   |
| Increase (decrease) in accrued compensation and  benefits                                                          |   | 2                                 |       | 1,638 |   | (5,410 | ) |
| Increase (decrease) in deferred revenues                                                                                |   | 3,231                             |       | 1,530 |   | (5,951 | ) |
| Increase (decrease) in other accrued liabilities                                                                        |   | (170                              | )          | 849 |   | (2,331 | ) |
| Net cash provided by operating activities                                                                               |   | 21,333                            |       | 34,873 |   | 28,928 |   |
|                                                                                                                    |   |                              |       |   |   |   |   |
| **Cash flows from investing activities:**                                                                               |   |                              |       |   |   |   |   |
| Purchases of short-term investments                                                                                     |   | (54,999                           | )          | — |   | — |   |
| Purchases of property and equipment                                                                                     |   | (3,986                            | )          | (2,290 | ) | (8,470 | ) |
| Net cash used in investing activities                                                                                   |   | (58,985                           | )          | (2,290 | ) | (8,470 | ) |
|                                                                                                                    |   |                              |       |   |   |   |   |
| **Cash flows from financing activities:**                                                                               |   |                              |       |   |   |   |   |
| Repurchase of common stock                                                                                              |   | (35,644                           | )          | — |   | — |   |
| Proceeds from issuance of common stock upon exercise  of stock options and purchases under employee stock purchase plan |   | 2,747                             |       | 1,604 |   | 3,012 |   |
| Net cash provided by (used in) financing activities                                                                     |   | (32,897                           | )          | 1,604 |   | 3,012 |   |
|                                                                                                                    |   |                              |       |   |   |   |   |
| Net increase (decrease) in cash and cash equivalents                                                                    |   | (70,549                           | )          | 34,187 |   | 23,470 |   |
| Cash and cash equivalents at beginning of period                                                                        |   | 189,076                           |       | 154,889 |   | 131,419 |   |
| Cash and cash equivalents at end of period                                                                              |   | $                                 | 118,527    |   | $ | 189,076 |   | $ | 154,889 |   |
|                                                                                                                    |   |                              |       |   |   |   |   |
| **Supplemental disclosures:**                                                                                           |   |                              |       |   |   |   |   |
| Income taxes paid                                                                                                       |   | $                                 | 2,564      |   | $ | 2,182 |   | $ | 508 |   |

 

See accompanying notes to consolidated financial statements.

 

F-5

----

 

**INETTECHNOLOGIES, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1 - Summary of SignificantAccounting Policies**

 

***The Company***

 

Inet Technologies, Inc.is a global provider of communications software products that enable communicationscarriers to more strategically and profitably operate their businesses. OurUnified Assurance Solution and our Diagnostics products help our customersreduce capital and operating expenditures, improve customer acquisition andretention rates, protect and grow revenues, and more quickly and effectivelydevelop products or services. Our products address next-generation networks,including mobile data and voice-over-packet technologies, and traditionalnetworks.

 

***Consolidation***

 

The consolidatedfinancial statements include the accounts of our wholly-ownedsubsidiaries.  Intercompany balances andtransactions have been eliminated.

 

***Accounting Estimates***

 

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples, or GAAP, requires us to make estimates and assumptions that affectthe amounts reported in the financial statements and accompanying notes. Asdiscussed below, we make significant estimates and assumptions in the areas ofrevenue recognition, accounts receivable, inventories and taxes. Although we believe that our estimates andassumptions are reasonable, actual results may differ, and such differencescould be significant to our financial results.

 

***Cash and Cash Equivalents***

 

Cashand cash equivalents consist of bank deposits, money-market funds and U.S.Treasury bills.  All highly-liquidsecurities with original maturities of three months or less are classified ascash equivalents. The carrying value of our bank deposits and money-marketfunds approximates fair market value. Our U.S. Treasury bills are classified as held to maturity and carriedat amortized cost.

 

***Short-term Investments***

 

Our short-terminvestments are classified as held to maturity and carried at amortized cost.Interest income includes amortization of the purchase discounts. AtDecember 31, 2003, our short-term investments were as follows (inthousands):

 
|                |   | **Amortized****Cost** |   | **Unrealized****Gains** |   | **Unrealized****Losses** |   | **Estimated****Fair Value** |   |
|---------------------|--------|-----------------------|--------|-------------------------|--------|--------------------------|--------|-----------------------------|--------|
| U.S. Treasury bills |   | $                     | 55,034 |                    | — |                     | — |                        | $      | 55,034 |   |
|                     |        |                       |        |                         |        |                          |        |                             |        |  |  |

 

AtDecember 31, 2002, we did not have any short-term investments.

 

F-6

----

 

***Inventories***

 

Inventoriesare valued at the lower of standard cost, which approximates actual costdetermined on a first-in, first-out basis, or market. Inventories consist ofthe following (in thousands):

 

|            |   | **December 31,** |       |
|-----------------|--------|-----------------------|------------|
|            |   | **2003**              |       | **2002** |   |
|            |   |                  | ** ** |   | ** ** |
| Raw materials   |   | $                     | 3,498      |   | $ | 3,774 |   |
| Work-in-process |   | 219                   |       | 445 |   |
| Finished goods  |   | 4,207                 |       | 3,239 |   |
|            |   | $                     | 7,924      |   | $ | 7,458 |   |

 

Inventoriesare recorded net of allowances for unsalable or obsolete raw materials,work-in-process and finished goods.  Weevaluate on a quarterly basis the status of our inventory to ensure the amountrecorded in our financial statements reflects the lower of our cost or the valuewe expect to receive when we sell the inventory.  This estimate is based on several factors, including thecondition and salability of our inventory and the forecasted demand for theparticular products incorporating inventory components.  Based on current backlog, expected ordersand other expected demand, we forecast the usage of current stock.  We record reserves for obsolete andslow-moving parts of up to 100% for excess parts with insufficient demand orobsolete parts.  Amounts inwork-in-process and finished goods inventory typically relate to firm ordersand, therefore, are not subject to obsolescence risk.

 

***Property and Equipment***

 

Propertyand equipment are stated at cost less accumulated depreciation and amortizationand are depreciated on a straight-line basis over their estimated useful lives,as follows:

 

| Computers and other equipment |   | 3-5  years     |   |
|-------------------------------|--------|----------------|--------|
| Software                      |   | 3  years       |   |
| Office furniture and fixtures |   | 7  years       |   |
| Leasehold improvements        |   | Term  of lease |   |

 

Reviewsare performed to determine whether facts or circumstances exist that indicatethe carrying values of our fixed assets are impaired. We assess therecoverability of our assets by comparing the projected undiscounted net cashflows associated with those assets to their respective carrying amounts.  Impairment, if any, is based on the excessof the carrying amount over the fair value of those assets.

 

***Research and Development Expenditures***

 

Ourresearch and development efforts include expenditures for new products andapplications, as well as enhancements to existing products, primarily in theareas of next-generation wireless and packet-based technologies.

 

Software developmentcosts are expensed as incurred until technological feasibility has beenestablished, at which time subsequent costs are permitted to be capitalizeduntil the product is available for general release to customers.  To date, either the establishment oftechnological feasibility of our products has substantially coincided withtheir general release, or costs incurred subsequent to the achievement oftechnological feasibility have not been material.  As a result, software development costs

 

F-7

----

 

qualifying for capitalization have been insignificant, and we have notcapitalized any software development costs.

 

***Revenue Recognition***

 

We derive revenues primarily from product and licensefees as well as services, which include training, warranty and product supportservices. The majority of the contracts for our GeoProbe, Orion and Beamerproducts contain multiple billing milestones, such as contract award, shipment,installation, ready for acceptance and acceptance, not all of which areassociated with revenue recognition. Except as otherwise discussed below,revenues from product and license fees are recognized in the period that wehave completed all hardware manufacturing and/or software development tocontractual specifications, factory testing has been completed, the product hasbeen shipped to the customer, the fee is fixed and determinable and collectionof the fee is considered probable.  Whenwe have significant obligations subsequent to shipment, such as installationand system integration, revenues are recognized when there are no significantunfulfilled obligations.  Revenues fromarrangements that include significant acceptance terms and/or provisions arerecognized when acceptance has occurred. Revenues from our Diagnostics products are typically recognized whentitle and risk of loss pass to the customer, which typically occurs atshipment.  For these products, wetypically have no significant obligations subsequent to shipment.  If a significant obligation were to exist,we would defer revenue recognition until such obligation was satisfied.  All shipping costs are included in cost ofrevenues in our consolidated statements of operations.

 

Contracts for our Unified Assurance products typicallyinvolve multiple deliverables.  Wedetermine the fair value of each of the contract deliverables usingvendor-specific objective evidence, or VSOE. VSOE for each element is based on the price for which we would sell theelement on a stand-alone basis. We offer our customers product supportservices, which include the correction of software problems, hardwarereplacements, telephone access to our technical personnel and the right toreceive unspecified product updates, upgrades and enhancements, when and ifthey become available.  Revenues fromthese services, including post-contract support included in initial licensingfees, are recognized ratably over the contract period.  Post-contract support included in theinitial licensing fee is allocated from the total contract amount based on thefair value of these services determined using VSOE.  Revenues from other services, such as training, are recognizedwhen the services have been completed.

 

Deferred revenues represent amounts billed tocustomers, but not yet recognized as revenue. Unbilled receivables represent amounts recognized as revenue, but notyet billed to customers.

 

***Concentration of Credit Risk***

 

Financial instruments whichpotentially subject us to concentration of credit risk consist primarily ofcash and cash equivalents, short-term investments and trade accountsreceivable. All cash equivalents are maintained with nationally recognizedfinancial institutions, which are insured to lessen the risk of loss.

 

A large portion of our revenues and accountsreceivable are attributable to our carrier customers in the communicationsindustry and, to a lesser extent, to our equipment manufacturer customers whosupply equipment into the communications industry. Our trade accountsreceivable balance is recorded net of allowances for amounts not expected to becollected from our customers. Because our accounts receivable are usually unsecured,we periodically evaluate the collectibility of our accounts based on acombination of factors, including a particular customer’s ability to pay andthe age of the receivables. To evaluate a specific customer’s ability to pay,we analyze the customer’s payment history, if any, financial

 

F-8

----

 

statements or other information provided by the customer, orthird-party credit analysis reports or other publicly-available information. Incases where the evidence suggests a customer may not be able to satisfy itsobligations to us, we set up a specific reserve in an amount we determineappropriate for the perceived risk. Most of our contracts include multiplepayment milestones, some of which occur in advance of revenue recognition,which mitigates our risk both in terms of collectibility and adjustments torecorded revenue. We have not historically experienced significant losses onuncollectible accounts and our allowance has been less than 5% of recorded receivables.

 

***Risks and Uncertainties***

 

Our future results of operationsand financial condition could be impacted by the following factors, amongothers: our dependence on the communications industry; general economicconditions; market growth for current- and next-generation network solutions;lengthy sales cycles for our products; less than anticipated demand for our newproducts; any delays in product implementations; customer and sector revenueconcentrations; the highly competitive marketplace in which we operate; ourdependence on key personnel; rapid technological change and our need tocontinually develop new products; the significance of our internationaloperations; currency exchange fluctuations; proprietary rights of us or othersand any product liability.

 

***Basis of Presentation***

 

Certain prior period amountshave been reclassified to conform to the current period presentation.

 

***Earnings Per Share***

 

Basic earnings per common sharedata is computed using the weighted-average number of common shares outstandingfor the relevant period.  Dilutedearnings per common share data is computed using the weighted-average number ofcommon shares outstanding plus common share equivalents represented by stockoptions and purchase rights, if such stock options and purchase rights have adilutive effect in the aggregate.

 

The following table sets forththe computation of basic and diluted earnings per share (in thousands, exceptper share data):

 

|                                                                                            |   | **Years Ended December 31,** |   |
|-------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                            |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                                                                            |   |                         |   |   |   |   | ** ** |
| Numerator:                                                                                      |   |                         |   |   |   |   |   |
| Net income for basic and diluted  earnings per share                                       |   | $                            | 11,691 |   | $ | 7,609 |   | $ | 193 |   |
| Denominator:                                                                                    |   |                         |   |   |   |   |   |
| Denominator for basic earnings per  share — weighted-average  shares                  |   | 39,059                       |   | 46,964 |   | 46,633 |   |
| Dilutive securities:  Employee  stock options and purchase rights                          |   | 458                          |   | 120 |   | 454 |   |
| Denominator for diluted earnings  per share — adjusted  weighted-average  shares |   | 39,517                       |   | 47,084 |   | 47,087 |   |
|                                                                                            |   |                         |   |   |   |   |   |
| Basic earnings per common share                                                                 |   | $                            | 0.30   |   | $ | 0.16 |   | $ | 0.00 |   |
|                                                                                            |   |                         |   |   |   |   |   |
| Diluted earnings per common share                                                               |   | $                            | 0.30   |   | $ | 0.16 |   | $ | 0.00 |   |

 

F-9

----

 

Outstanding employee stockoptions to purchase 1,769,912 shares at December 31, 2003, 3,412,435 shares atDecember 31, 2002 and 2,194,397 shares at December 31, 2001, were not includedin the respective earnings per share calculations because the effect of theirinclusion would have been anti-dilutive.

 

***Stock Options***

 

We have elected to followAccounting Principles Board, or APB, Opinion No. 25*, Accounting for Stock Issued toEmployees*, in accounting for our employee stock options. Under APB25, if the exercise price of an employee’s stock options equals or exceeds themarket price of the underlying stock on the date of grant, no compensationexpense is recognized.  At December 31,2003, we had three stock-based compensation plans covering employees anddirectors.  These plans are describedmore fully in Note 7.  We account forstock-based compensation for non-employees under the fair value methodprescribed by SFAS 123, *Accounting for Stock-Based Compensation*.  Through December 31, 2003, there have beenno significant grants to non-employees. Unearned stock compensation related to our Stock Issuance Programdescribed in Note 7 was $2.6 million as of December 31, 2003 and $0.4 millionas of December 31, 2002.  We had nounearned stock compensation at December 31, 2001.

 

Although SFAS 123 allows us tocontinue to follow the present APB 25 guidelines, we also disclose pro formanet income (loss) and net income (loss) per share as if we had adopted SFAS123.  The pro forma impact of applyingSFAS 123 in fiscal 2003, 2002 and 2001 will not necessarily be representativeof the pro forma impact in future years. Our pro forma information is as follows (in thousands, except per sharedata):

 

|                                                                                              |   | **Years Ended December 31,** |   |
|---------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                              |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                                                                              |   |                         |   |   |   |   |   |
| Net income, as reported                                                                           |   | $                            | 11,691 |   | $ | 7,609 |   | $ | 193 |   |
| Stock compensation expense recorded under the intrinsic value method,  net of income taxes        |   | 259                          |   | 13 |   | — |   |
| Pro forma stock compensation (expense) computed under the fair value  method, net of income taxes |   | (3,900                       | )      | (12,877 | ) | (21,702 | ) |
| Pro forma net income (loss)                                                                       |   | $                            | 8,050  |   | $ | (5,255 | ) | $ | (21,509 | ) |
|                                                                                              |   |                         |   |   |   |   |   |
| Basic earnings per common share, as reported                                                      |   | $                            | 0.30   |   | $ | 0.16 |   | $ | 0.00 |   |
| Diluted earnings per common share, as reported                                                    |   | $                            | 0.30   |   | $ | 0.16 |   | $ | 0.00 |   |
|                                                                                              |   |                         |   |   |   |   |   |
| Pro forma basic earnings (loss) per common share                                                  |   | $                            | 0.21   |   | $ | (0.11 | ) | $ | (0.46 | ) |
| Pro forma diluted earnings (loss) per common share                                                |   | $                            | 0.20   |   | $ | (0.11 | ) | $ | (0.46 | ) |

 

Inputs used for the fair valuemethod for our employee stock options are as follows:

 

|                                           |   | **Years Ended December 31,** |   |
|------------------------------------------------|--------|------------------------------|--------|
|                                           |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                           |   |                         |   |   |   |   |   |
| Volatility                                     |   | 0.91                         |   | 0.99 |   | 1.09 |   |
| Weighted-average expected lives                |   | 3.63                         |   | 3.70 |   | 3.70 |   |
| Expected dividend yields                       |   | —                       |   | — |   | — |   |
| Weighted-average risk-free interest rates      |   | 2.62                         | %      | 2.02 | % | 4.62 | % |
| Weighted-average fair value of options granted |   | $                            | 8.02   |   | $ | 3.59 |   | $ | 10.68 |   |
|                                                |        |                              |        |  |  |  |  |  |  |  |

 

F-10

----

 

Inputs used for the fair valuemethod for our employee stock purchase rights are as follows:

 

|                                                          |   | **Years Ended December 31,** |   |
|---------------------------------------------------------------|--------|------------------------------|--------|
|                                                          |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                                          |   |                         |   |   |   |   |   |
| Volatility                                                    |   | 0.97                         |   | 1.02 |   | 1.07 |   |
| Weighted-average expected lives                               |   | 0.50                         |   | 0.50 |   | 0.50 |   |
| Expected dividend yields                                      |   | —                       |   | — |   | — |   |
| Weighted-average risk-free interest rates                     |   | 1.31                         | %      | 1.70 | % | 3.02 | % |
| Weighted-average fair value of employee stock purchase rights |   | $                            | 2.95   |   | $ | 3.10 |   | $ | 9.05 |   |
|                                                               |        |                              |        |  |  |  |  |  |  |  |

 

***Income Taxes***

 

Our income taxes are computed using the asset andliability method of accounting.  Underthe asset and liability method, a deferred tax asset or liability is recognizedfor estimated future tax effects attributable to temporary differences andcarryforwards.

 

In the preparation of our provision for income taxesand determination of whether deferred tax assets will be realized in full or inpart, we must estimate several factors. When it is more likely than not that all or some portion of the deferredtax asset will not be realized, a valuation allowance must be established forthe amount of the deferred tax assets that are determined not to be realizable.As of December 31, 2003 and 2002, a valuation for deferred tax assets was notdeemed necessary.  Accordingly, if thefacts or financial results were to change, thereby impacting the likelihood ofrealizing the deferred tax assets, judgment would have to be applied todetermine the amount of valuation allowance required in any given period.  Additionally, our income tax returns aresubject to review and examination in the various jurisdictions in which weoperate.  We are currently not aware ofany material issues that have been raised by taxing jurisdictions andmanagement believes that all income tax issues which may be raised as a resultof such reviews and examinations in the future will be resolved with nomaterial impact on the financial position or future results of operations.  However, in the event there was anassessment by any of these jurisdictions, it could impact our tax provision.

 

***Recent Accounting Pronouncements***

 

In July 2002, the Financial Accounting StandardsBoard, or FASB, issued SFAS No. 146, *Accounting for Costs Associated with Exit or DisposalActivities*. This statement nullifies Emerging Issues Task Force, orEITF Issue No. 94-3, *Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring)*. The standard requires companies to recognize costs associated with exitor disposal activities when they are incurred rather than at the date ofcommitment to an exit or disposal plan. This statement is to be applied prospectively to exit or disposalactivities initiated after December 31, 2002. The adoption of this standard did not have an effect on our financialposition or results of operations.

 

**Note 2 - Related Party Transactions**

 

In October 2003, we completed anunderwritten secondary offering of our common stock.  All shares were offered by two of our founders, Elie S. Akilian,our president, chief executive officer and director, and Samuel S. Simonian,the chairman of our board of directors. Since we did not issue any new shares, we did not receive any of theproceeds from the sale of common stock. We effected the offering pursuant to a demand made by the sellingshareholders in accordance with the rights granted to them under the

 

F-11

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registration rights agreement dated July 23,1998.  We paid all of the expenses ofthe offering incurred by us and certain fees and expenses of the sellingstockholders, excluding underwritten discounts and commissions.  Total expenses of approximately $0.4 millionfor accounting, legal and professional fees are included on our 2003 financialstatements.

 

Effective September 30, 2003, weamended and extended the July 23, 1998 registration rights agreement.  Under the new agreement, Messrs. Akilian andSimonian will each be entitled to demand, prior to October 1, 2008, up to tworegistrations of firm-commitment underwritten offerings of their common stock.  The selling stockholder or stockholders willbe required to pay all of their and our expenses incurred in connection withany demand-based registrations.

 

On January 21, 2003, werepurchased in a privately-negotiated transaction 8,969,984 restricted sharesof our common stock from Mark A. Weinzierl, one of our founders and a member ofour board of directors, for an aggregate cash purchase price of approximately$35.4 million. We funded the transaction with available cash.  The shares repurchased representedapproximately 19% of our total shares outstanding immediately prior to thetransaction.  Effective as of theclosing of the transaction, Mr. Weinzierl resigned from our board of directors.

 

Epygi Technologies, Ltd., an entity controlled bySamuel S. Simonian, one of our founders and chairman of our board, currentlyperforms development services for us pursuant to a consulting agreement forwhich it is paid a monthly fee per full-time programmer plus reimbursement ofreasonable business expenses.  We expensed$0.3 million for these services in 2003, $0.9 million in 2002 and $1.4 millionin 2001.

 

**Note 3 –Restructuring Costs**

 

In the quarter ended September 30, 2002, we recorded arestructuring charge of approximately $0.4 million related primarily to aworkforce reduction of approximately 35 employees. The reduction affected allareas of the company.  The chargeconsisted primarily of employee severance of approximately $0.3 million andprofessional fees and outplacement services of approximately $0.1 million.  At December 31, 2002, the balance of thesecosts that remained to be paid was approximately $0.1 million.  At December 31, 2003, substantially allcosts associated with this restructuring had been paid.

 

In May 2001, we announced our decision to refocus ourstrategy and streamline operations to reduce our cost structure in response tothe generally weakened economic environment and changing demand characteristicsin some of our markets.  As part of thisdecision, we discontinued all efforts with respect to our VIATMsoftswitch offering and reduced our workforce by approximately 115employees.  The reduction affected allareas of the company. We recorded a restructuring charge for the three monthsended June 30, 2001 of approximately $1.7 million, which consisted of employeeseverance of approximately $1.1 million, professional fees and outplacementservices of approximately $0.3 million and the write-off of assets related tothe VIA softswitch of approximately $0.3 million. In the fourth quarter of 2001,we decreased this charge by $0.1 million due to changes in previous estimatesrelated to professional fees.  In thethird quarter of 2002, we decreased this charge by $0.2 million due to changesin previous estimates related to professional fees and employee-relatedobligations. All costs associated with this restructuring were paid by December31, 2002.

 

We recorded a restructuring charge for the threemonths ended March 31, 2001 of approximately $0.5 million related primarily toa workforce reduction of approximately 40 employees. The reduction

 

F-12

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affected all areas of the company. The charge consisted primarily of employee severance, professional feesand outplacement services.  In thefourth quarter of 2001, we decreased this charge by $0.1 million due to changesin previous estimates related to severance and professional fees.  All costs associated with this workforcereduction were paid by December 31, 2002.

 

**Note 4 - Property and Equipment**

 

Property and equipment consistsof the following (in thousands):

 

|                                                  |   | **December 31,** |       |
|-------------------------------------------------------|--------|------------------|------------|
|                                                  |   | **2003**         |       | **2002** |   |
|                                                  |   |             | ** ** |   | ** ** |
| Computer and other equipment                          |   | $                | 26,244     |   | $ | 23,991 |   |
| Software                                              |   | 7,376            |       | 6,900 |   |
| Office furniture, fixtures and leasehold improvements |   | 8,545            |       | 8,336 |   |
|                                                  |   | 42,165           |       | 39,227 |   |
| Less accumulated depreciation and amortization        |   | 30,835           |       | 24,012 |   |
|                                                  |   | $                | 11,330     |   | $ | 15,215 |   |

 

**Note 5 - Income Taxes**

 

Components of the provision(benefit) for income taxes were as follows (in thousands):

 

|                                 |   | **Years Ended December 31,** |       |
|--------------------------------------|--------|------------------------------|------------|
|                                 |   | **2003**                     |       | **2002** |   | **2001** |   |
|                                 |   |                         | ** ** |   | ** ** |   | ** ** |
| Current federal provision (benefit)  |   | $                            | 4,633      |   | $ | 1,194 |   | $ | (450 | ) |
| Current state provision              |   | 584                          |       | 335 |   | — |   |
| Current foreign provision            |   | 545                          |       | 350 |   | 139 |   |
| Deferred federal provision (benefit) |   | (967                         | )          | 1,306 |   | (1,116 | ) |
| Deferred state provision (benefit)   |   | (45                          | )          | (12 | ) | 137 |   |
|                                 |   | $                            | 4,750      |   | $ | 3,173 |   | $ | (1,290 | ) |

 

The provision (benefit) forincome taxes is reconciled with the federal statutory rate as follows (inthousands):

 

|                                                     |   | **Years Ended December 31,** |       |
|----------------------------------------------------------|--------|------------------------------|------------|
|                                                     |   | **2003**                     |       | **2002** |   | **2001** |   |
|                                                     |   |                         | ** ** |   | ** ** |   | ** ** |
| Provision (benefit) computed at federal statutory rate   |   | $                            | 5,754      |   | $ | 3,774 |   | $ | (384 | ) |
| Research and development tax credits                     |   | (828                         | )          | (902 | ) | (1,072 | ) |
| Extraterritorial income exclusion                        |   | (653                         | )          | (216 | ) | (92 | ) |
| State income taxes (benefits), net of federal tax effect |   | 379                          |       | 210 |   | (14 | ) |
| Other                                                    |   | 98                           |       | 307 |   | 272 |   |
|                                                     |   | $                            | 4,750      |   | $ | 3,173 |   | $ | (1,290 | ) |

 

F-13

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The significant components ofour deferred tax assets and liabilities were as follows (in thousands):

 

|                                                                           |   | **December 31,** |       |
|--------------------------------------------------------------------------------|--------|------------------|------------|
|                                                                           |   | **2003**         |       | **2002** |   |
|                                                                           |   |             | ** ** |   | ** ** |
| Deferred tax assets:                                                           |   |             |       |   |   |
| Deferred revenues                                                              |   | $                | 824        |   | $ | — |   |
| Depreciation                                                                   |   | 217              |       | — |   |
| Inventories                                                                    |   | 219              |       | 412 |   |
| Allowance for doubtful accounts                                                |   | 203              |       | 192 |   |
| Reserves and other accrued expenses not currently deductible for tax  purposes |   | 382              |       | 411 |   |
| Total deferred tax assets                                                      |   | 1,845            |       | 1,015 |   |
| Deferred tax liabilities:                                                      |   |             |       |   |   |
| Depreciation                                                                   |   | —           |       | (18 | ) |
| Deferred revenues                                                              |   | —           |       | (54 | ) |
| Other                                                                          |   | —           |       | (111 | ) |
| Total deferred tax liabilities                                                 |   | —           |       | (183 | ) |
|                                                                           |   | $                | 1,845      |   | $ | 832 |   |

 

**Note 6 – Commitments and Contingencies**

 

We lease our corporate officefacility, as well as facilities near the cities of London, England;  Frankfurt, Germany; Paris, France and Milan,Italy under noncancelable operating lease agreements. Rental expense for these operatingleases was $6.3 million in 2003, $6.0 million in 2002 and $6.0 million in 2001.

 

We are obligated to make futurepayments under various contracts, including non-cancelable inventory purchasecommitments and the operating leases. The following table summarizes our contractual cash obligations as ofDecember 31, 2003 (in thousands):

 

|                 |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **2008** |   | **Thereafter** |   |
|----------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|
| Purchase commitments |   | $        | 4,595  |     | $      | —   |   | $        | — |     | $      | —         |   | $ | — |   | $ | — |   |
| Operating leases     |   | 6,097    |   | 6,248    |   | 6,348    |   | 6,348    |   | 6,348    |   | 11,566         |   |
| Total                |   | $        | 10,692 |     | $      | 6,248    |   | $        | 6,348  |     | $      | 6,348          |   | $ | 6,348 |   | $ | 11,566 |   |

 

We are involved in various legal proceedings andclaims that arise in the normal course of our business. While many of thesematters involve inherent uncertainty, our management believes that the amountof the liability, if any, ultimately incurred by us with respect to anyexisting proceedings and claims, net of applicable reserves and availableinsurance, will not materially harm our business, financial condition orresults of operations.

 

**Note 7 - Stockholders’ Equity**

 

***Preferred Stock***

 

Our board of directors has theauthority to issue up to 25,000,000 shares of preferred stock in one or moreseries and to fix the rights, preferences, privileges and restrictions thereof,including dividend rights, dividend rates, conversion rights, voting rights,terms of redemption, redemption prices,

 

F-14

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liquidation preferences and the number of sharesconstituting any series or the designation of such series, without further voteor action by the stockholders.

 

***Stock Option and Employee Stock PurchasePlans***

 

Our 1998 Stock Option/StockIssuance Plan, or the 1998 Plan, is our successor equity incentive program toour 1995 Employee Stock Option Plan, or the 1995 Plan. The 1998 Plan becameeffective on July 23, 1998 upon adoption by our board of directors and wassubsequently approved by our stockholders on July 23, 1998 and ratified by ourstockholders on May 12, 2003. At December 31, 2003, common stock authorized forissuance pursuant to options granted or available for grant under the 1998 Planwas 6,413,611 shares. The share reserve automatically increases on the firsttrading day of January each calendar year by a number of shares equal to onepercent (1%) of the total number of shares of common stock outstanding on thelast trading day of the immediately preceding calendar year.  No such annual increase can exceed 500,000shares.  In no event may any oneparticipant in the 1998 Plan receive option grants or direct stock issuancesfor more than 1,000,000 shares in the aggregate in a calendar year.  During the year ended December 31, 2003, allstock options granted were under the 1998 Plan.

 

The 1998 Plan is divided intothree separate components: (i) the Discretionary Option Grant Program, underwhich eligible individuals in our employ or service (including officers,non-employee directors and consultants) may, at the discretion of the planadministrator, be granted options to purchase shares of common stock at anexercise price determined by the plan administrator, which is generally thefair market value of those shares on the grant date, (ii) the Stock IssuanceProgram, under which such individuals may, in the plan administrator’s discretion,be issued shares of common stock directly, through the purchase of such sharesat a price determined by the plan administrator or as a bonus tied to theperformance of services and (iii) the Automatic Option Grant Program, underwhich option grants will automatically be made at periodic intervals toeligible non-employee directors to purchase shares of common stock at anexercise price equal to 100% of the fair market value of those shares on thegrant date.  Generally, options grantedunder the Discretionary Option Grant Program become exercisable ratably over aperiod of four years and expire ten years from the date of grant.  Options granted under the Automatic OptionGrant Program are immediately exercisable, vest ratably over a period of one orthree years, and expire ten years from the date of grant. Generally, restrictedstock granted under the Stock Issuance Program vest ratably over a period ofthree or four years. Upon a grantee’s termination of service, anyunvested shares of restricted stock may be repurchased by us at the fair marketvalue on the date of grant. Share rightawards granted under the Stock Issuance Program pursuant to which the granteemay receive a specified number of shares upon the attainment of specifiedperformance goals or service requirements vest ratably over a period of fouryears. Upon a grantee’s termination of service, any unvested restrictedstock units are canceled.

 

Our 1995 Plan provided forincentive options and nonqualified options that were granted to our key employees,officers and directors. Options were granted generally at prices not less thanthe fair value of our common stock as determined by our board of directors atthe dates of grant. Options granted under the 1995 Plan vest at ratesestablished by our board and expire ten years after the date of grant.

 

Outstanding options under the1995 Plan have been incorporated into the 1998 Plan, and no further optiongrants will be made under the 1995 Plan. The incorporated options will continueto be governed by their existing terms, unless the plan administrator elects toextend one or more features of the 1998 Plan to those options. However, exceptas otherwise noted above, the outstanding options under the 1995 Plan containsubstantially the same terms and conditions summarized above for theDiscretionary Option Grant Program in effect under the 1998 Plan.

 

F-15

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Stock option transactions forthe years ended December 31, 2003, 2002 and 2001 are summarized as follows:

 

|                                                             |   | **Years Ended December 31,** |   |
|------------------------------------------------------------------|--------|------------------------------|--------|
|                                                             |   | **2003**                     |   | **2002** |   | **2001** |   |
|                                                             |   | **Number of  Options**       |   | **Weighted -  Average  Exercise  Price** |   | **Number of  Options** |   | **Weighted -  Average  Exercise  Price** |   | **Number of  Options** |   | **Weighted -  Average  Exercise  Price** |   |
| Outstanding at beginning of period                               |   | 3,807,133                    |   | $ | 22.61 |   | 3,805,649 |   | $ | 24.38 |   | 2,571,500 |   | $ | 30.56 |   |
| Granted                                                          |   | 910,300                      |   | 12.90 |   | 388,400 |   | 5.59 |   | 1,882,022 |   | 15.04 |   |
| Exercised                                                        |   | (209,907                     | )      | 6.90 |   | (29,850 | ) | 3.98 |   | (249,250 | ) | 3.32 |   |
| Forfeited                                                        |   | (617,990                     | )      | 31.13 |   | (357,066 | ) | 24.50 |   | (398,623 | ) | 33.33 |   |
| Outstanding at end of period                                     |   | 3,889,536                    |   | 19.83 |   | 3,807,133 |   | 22.61 |   | 3,805,649 |   | 24.38 |   |
| Weighted-average fair value of options granted during the period |   | $                            | 8.02   |   |   |   | $ | 3.59 |   |   |   | $ | 10.68 |   |   |   |
|                                                                  |        |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

At December 31, 2003, 1,831,617shares were exercisable at a weighted-average exercise price of $24.76 and2,524,075 shares were available for future grants to employees under the 1998Plan.

 

Information related to optionsoutstanding at December 31, 2003 is summarized below:

 
|                |   | **Options Outstanding** |   | **Options Exercisable**                           |   |
|---------------------|--------|-------------------------|--------|---------------------------------------------------|--------|
| **Exercise Prices** |   | **Number of  Options**  |   | **Weighted-Average  Remaining  Contractual Life** |   | **Weighted-Average  Exercise Price** |   | **Number of  Options** |   | **Weighted-Average  Exercise Price** |   |
| $1.15 - $5.06       |   | 443,650                 |   | 7.13                                              |   | $ | 4.73 |   | 228,825 |   | $ | 4.44 |   |
| $5.11 - $8.20       |   | 901,846                 |   | 7.47                                              |   | 8.11 |   | 392,861 |   | 8.17 |   |
| $8.21 - $20.63      |   | 1,449,425               |   | 8.71                                              |   | 13.84 |   | 410,363 |   | 15.62 |   |
| $22.56 - $45.50     |   | 676,440                 |   | 6.62                                              |   | 38.84 |   | 506,303 |   | 38.71 |   |
| $46.00 - $67.00     |   | 418,175                 |   | 6.45                                              |   | 51.11 |   | 293,265 |   | 51.53 |   |
|                     |        |                         |        |                                                   |        |  |  |  |  |  |  |  |  |

 

Restricted stock grants underour Stock Issuance Program totaled 193,000 shares in 2003 and 84,000 shares in2002.  Unearned stock compensationassociated with these grants totaled $2.6 million in 2003 and $0.4 million in2002 and is being recognized ratably over the vesting period. We had norestricted stock grants in 2001.  In2003, we granted 19,000 share right awards. Compensation expense associated with these share right awards grants isbeing recognized ratably over the vesting period.  We had no share right awards in 2002 or 2001.

 

Our Employee Stock PurchasePlan, or the Purchase Plan, was adopted by our board of directors and approvedby our stockholders on July 23, 1998. The Purchase Plan provides for theissuance of up to 1,250,000 shares of common stock.  Eligible employees can have up to 15% of their earnings withheld,subject to certain limitations, to be used to purchase shares of our commonstock on every January 31st and July 31st.  The price of the common stock purchasedunder the Purchase Plan will be equal to 85% of the lower of the fair marketvalue of the common stock on the commencement date of the offering period orthe fair market value of the common stock on the specified purchase date.  The Purchase Plan has been implemented in aseries of successive offering periods, each with a maximum duration of 24months.  At December 31, 2003, 1,006,941shares had been issued under the Purchase Plan and 243,059 shares were reservedfor future purchases under the Purchase Plan.

 

**Note 8 - Segment Information**

 

We operate in a single industrysegment, providing communications software solutions and associated services toour customers through our sales personnel and certain foreign resellers.  As a

 

F-16

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result, the financial information disclosed inthis report represents all material financial information related to our soleoperating segment.  The geographicdistribution of our revenues as a percentage of total revenues is as follows:

 

|                           |   | **Years Ended December 31,** |       |
|--------------------------------|--------|------------------------------|------------|
|                           |   | **2003**                     |       | **2002** |   | **2001** |   |
|                           |   |                         | ** ** |   | ** ** |   | ** ** |
| United States                  |   | 26.8                         | %          | 27.8 | % | 38.3 | % |
| Export:                        |   |                         |       |   |   |   |   |
| Asia/Pacific                   |   | 7.6                          |       | 8.0 |   | 5.5 |   |
| Europe, Middle East and Africa |   | 63.9                         |       | 60.9 |   | 51.9 |   |
| Other                          |   | 1.7                          |       | 3.3 |   | 4.3 |   |
| Total export revenues          |   | 73.2                         |       | 72.2 |   | 61.7 |   |
|                           |   | 100.0                        | %          | 100.0 | % | 100.0 | % |

 

We have no significantlong-lived assets deployed outside of the U.S.

 

In both 2003 and 2002, British Telecom accounted forapproximately 21% of total revenues and Deutsche Telekom accounted forapproximately 11% of total revenues. In 2001, revenues from Deutsche Telekomaccounted for approximately 12% of total revenues. If we were to lose one ormore of our significant customers, our financial results could be harmed.  Sales tocustomers in the United Kingdom accounted for approximately 30% of totalrevenues in 2003, approximately 27% of total revenues in 2002 and approximately19% of total revenues in 2001. Sales to customers in Germany accounted forapproximately 12% of total revenues in 2003, approximately 11% of totalrevenues during 2002 and approximately 14% of total revenues during 2001.  No other individual customer or countryaccounted for 10% or more of total revenues in 2003, 2002 or 2001.

 

**Note 9 - Employee Benefit Plan**

 

We have a retirement savingsplan structured under Section 401(k) of the Internal Revenue Code, or the Code.The plan covers substantially all employees meeting minimum servicerequirements. Under the plan, employees may elect to reduce their currentcompensation by up to 25%, subject to certain maximum dollar limitationsprescribed by the Code, and have the amount contributed to the plan as salarydeferral contributions. We may make contributions to the plan at the discretionof our board of directors. We accrued discretionary contributions to the plantotaling $0.6 million in both 2003 and 2002. No discretionary contributionswere accrued in 2001.

 

F-17

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**Note 10 - Quarterly Financial Information (unaudited)**

 

The following table containsselected financial information from unaudited consolidated statements ofoperations for each quarter of 2003 and 2002.

 
|                                                |   | **Quarter Ended**                         |   |
|-----------------------------------------------------|--------|-------------------------------------------|--------|
|                                                |   | **2003**                                  |   | **2002** |   |
|                                                |   | **Dec. 31**                               |   | **Sept. 30** |   | **June 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sept. 30** |   | **June 30** |   | **Mar. 31** |   |
|                                                |   | **(In thousands, except per share data)** |   |
| Revenues                                            |   | $                                         | 27,271 |   | $ | 26,034 |   | $ | 25,472 |   | $ | 25,042 |   | $ | 25,015 |   | $ | 23,156 |   | $ | 26,220 |   | $ | 27,495 |   |
| Gross profit                                        |   | 18,313                                    |   | 17,574 |   | 15,833 |   | 17,973 |   | 16,341 |   | 13,173 |   | 14,942 |   | 18,105 |   |
| Net income                                          |   | 3,387                                     |   | 2,778 |   | 2,271 |   | 3,255 |   | 2,738 |   | 806 |   | 1,325 |   | 2,740 |   |
| Basic earnings per share (1)                        |   | $                                         | 0.09   |   | $ | 0.07 |   | $ | 0.06 |   | $ | 0.08 |   | $ | 0.06 |   | $ | 0.02 |   | $ | 0.03 |   | $ | 0.06 |   |
| Diluted earnings per share (1)                      |   | $                                         | 0.09   |   | $ | 0.07 |   | $ | 0.06 |   | $ | 0.08 |   | $ | 0.06 |   | $ | 0.02 |   | $ | 0.03 |   | $ | 0.06 |   |
| Shares used in computing basic earnings per share   |   | 38,852                                    |   | 38,612 |   | 38,400 |   | 40,395 |   | 47,116 |   | 47,011 |   | 46,888 |   | 46,838 |   |
| Shares used in computing diluted earnings per share |   | 39,567                                    |   | 39,238 |   | 38,689 |   | 40,563 |   | 47,191 |   | 47,043 |   | 47,092 |   | 47,194 |   |

 

----

(1)    Earningsper common share are computed independently for each of the quarterspresented.  Therefore, the sum of thequarterly earnings per common share information may not equal the annualearnings per common share due to rounding differences.

 

F-18

----

 

**REPORTOF****INDEPENDENT AUDITORS**

 

 

The Board of DirectorsInet Technologies, Inc.

 

We have audited the consolidated financial statements of InetTechnologies, Inc. as of December 31, 2003 and 2002, and for each of the threeyears in the period ended December 31, 2003, and have issued our report thereondated January 26, 2004. Our audits also included the financial statementschedule listed in Item 15 of this Form 10-K. This schedule is theresponsibility of the Company’s management. Our responsibility is to express anopinion based on our audits.

 

In our opinion, the financial statement schedule referred to above,when considered in relation to the basic financial statements taken as a whole,presents fairly in all material respects the information set forth therein.

 

 
|   |  |
|--------|--|

 

 

Dallas, TexasJanuary 26, 2004

 

----

 

**INET****TECHNOLOGIES, INC.SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS**Years Ended December 31, 2003, 2002 and 2001(In thousands)

 
|                                                                |   | **Balance at  Beginning  of Year** |   | **Additions or  Deductions  Charged  (Credited) to  Costs and  Expenses** |   | **Deductions (1)** |   | **Balance at  End of Year** |   |
|---------------------------------------------------------------------|--------|------------------------------------|--------|---------------------------------------------------------------------------|--------|--------------------|--------|-----------------------------|--------|
| Year ended December 31, 2003:                                       |   |                               |   |                                                                      |   |               |   |                        |   |
| Deducted from asset accounts—  Allowance for doubtful accounts |   | $                                  | 484    |                                                                      | $      | 31                 |   | $                           | (1     | ) | $ | 514 |   |
|                                                                |   |                               |   |                                                                      |   |               |   |                        |   |
| Year ended December 31, 2002:                                       |   |                               |   |                                                                      |   |               |   |                        |   |
| Deducted from asset accounts—  Allowance for doubtful accounts |   | $                                  | 723    |                                                                      | $      | (259               | )      | $                           | 20     |   | $ | 484 |   |
|                                                                |   |                               |   |                                                                      |   |               |   |                        |   |
| Year ended December 31, 2001:                                       |   |                               |   |                                                                      |   |               |   |                        |   |
| Deducted from asset accounts—  Allowance for doubtful accounts |   | $                                  | 1,065  |                                                                      | $      | (105               | )      | $                           | (237   | ) | $ | 723 |   |

 

----

(1)    Activity includes uncollectible accountswritten off, net of recoveries.

 

----

 

**INET TECHNOLOGIES, INC.INDEX TO EXHIBITS**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                           |
|---------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                      |
| 3.1                 |   | Certificate of Incorporation  (1)                                                                                                                                         |
| 3.2                 |   | Amended and Restated Bylaws  (1)                                                                                                                                          |
| 4.1                 |   | Specimen Common Stock certificate  (1)                                                                                                                                    |
| 4.2                 |   | See Exhibits 3.1 and 3.2 for  provisions of the Certificate of Incorporation and Bylaws of the registrant  defining the rights of holders of common stock                 |
| 10.1                |   | Form of Indemnification  Agreement between the registrant and each of its directors and executive  officers (11)                                                          |
| 10.2                |   | Amended and Restated  Registration Rights Agreement dated as of September 30, 2003 by and among the  registrant, Samuel S. Simonian and Elie S. Akilian (12)              |
| 10.3                |   | Inet Technologies, Inc. 1998  Employee Stock Purchase Plan (8)                                                                                                            |
| 10.4                |   | First Amendment to the Inet  Technologies, Inc. 1998 Employee Stock Purchase Plan (4)                                                                                     |
| 10.5                |   | Second Amendment to the Inet  Technologies, Inc. 1998 Employee Stock Purchase Plan (8)                                                                                    |
| 10.6                |   | Lease dated as of January 27,  2000 by and among Collins Crossing, LTD. and the registrant (5)                                                                            |
| 10.7                |   | Lease Amendment No. 1 dated  March 31, 2000 by and among Collins Crossing, LTD. and the registrant (6)                                                                    |
| 10.8                |   | Lease Amendment No. 2 dated  June 1, 2000 by and among Collins Crossing, LTD. and the registrant (6)                                                                      |
| 10.9                |   | Letter Agreement dated June 2,  2000 between the registrant and Mark H. Kleinman (7) (10)                                                                                 |
| 10.10               |   | Inet Technologies, Inc. 1998  Stock Option/Stock Issuance Plan (1) (7)                                                                                                    |
| 10.11               |   | Stock Repurchase Agreement  dated January 16, 2003 between the registrant and Mark A. Weinzierl (2)                                                                       |
| 10.12               |   | Consulting Agreement dated April 1, 2002 between  Epygi Technologies, Ltd. and the registrant (9)                                                                         |
| 21.1                |   | Subsidiaries of the registrant  (3)                                                                                                                                       |
| 23.1                |   | Consent of Ernst & Young  LLP (3)                                                                                                                                     |
| 24.1                |   | Power of Attorney, pursuant to  which amendments to this report may be filed, is included on the signature  page contained in Part IV hereof                              |
| 31.1                |   | Certification  of Elie S. Akilian, President and Chief Executive Officer of the Company, as  adopted pursuant to  Section 302 of  the Sarbanes-Oxley Act of 2002 (3) |
| 31.2                |   | Certification  of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the  Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  (3)  |
| 32.1                |   | Certification  of Elie S. Akilian, President and Chief Executive Officer of the Company, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  (3)       |
| 32.2                |   | Certification  of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the  Company, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  (3)  |

 

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| (1) |   | Previously filed as an exhibit  to the registrant’s Registration Statement on Form S-1 (Reg. No. 333-59753)  and incorporated herein by reference. |
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| (2) |   | Previously filed as an exhibit  to the registrant’s Current Report on Form 8-K                                                                     |

 

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|   |   | dated January 21, 2003 and  incorporated herein by reference.                                                                                                          |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3)    |   | Filed herewith.                                                                                                                                                        |
| (4)    |   | Previously filed as an exhibit  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June  30, 2001 and incorporated herein by reference.      |
| (5)    |   | Previously filed as an exhibit  to the registrant’s Annual Report on Form 10-K for the year ended December  31, 1999 and incorporated herein by reference.        |
| (6)    |   | Previously filed as an exhibit  to the registrant’s Annual Report on Form 10-K for the year ended December  31, 2000 and incorporated herein by reference.        |
| (7)    |   | Management contract or  compensatory plan or arrangement.                                                                                                              |
| (8)    |   | Previously filed as an exhibit  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June  30, 2002 and incorporated herein by reference.      |
| (9)    |   | Previously filed as an exhibit  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended March  31, 2002 and incorporated herein by reference.     |
| (10)   |   | Previously filed as an exhibit  to the registrant’s Annual Report on Form 10-K for the year ended December  31, 2001 and incorporated herein by reference.        |
| (11)   |   | Previously filed as an exhibit  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June  30, 2003 and incorporated herein by reference.      |
| (12)   |   | Previously filed as an exhibit  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2003 and incorporated herein by reference. |

 

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