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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.
|- | -----------------------------------------------------------------------------------------



| | For the quarterly period ended September 30, 2003
| | -------------------------------------------------



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.
|- | ------------------------------------------------------------------------------------------



Commission File Number 0-24707



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INET TECHNOLOGIES, INC.

(Exact name of registrant as 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, including zip code)



(469) 330-4000

(Registrants telephone number, including area code)



---



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule
12b-2).    Yes  x    No ̈



Number of shares of common stock outstanding at October
17, 2003: 38,725,161



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Inet Technologies, Inc.

Index



|                             |  |         |  |                                                                                       |  | Page No.
|---------------------------- |  | ------- |  | ------------------------------------------------------------------------------------- |  | --------
|Part IFinancial Information |  |        
|                             |  |         | 
|                             |  | Item 1. |  | Financial Statements                                                                  |  |         
|                             |  |         | 
|                             |  |         |  | Consolidated Balance Sheets                                                           |  | 3       
|                             |  |         | 
|                             |  |         |  | Consolidated Statements of Income                                                     |  | 4       
|                             |  |         | 
|                             |  |         |  | Consolidated Statement of Stockholders Equity                                        |  | 5       
|                             |  |         | 
|                             |  |         |  | Consolidated Statements of Cash Flows                                                 |  | 6       
|                             |  |         | 
|                             |  |         |  | Notes to Consolidated Financial Statements                                            |  | 7       
|                             |  |         | 
|                             |  | Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 14      
|                             |  |         | 
|                             |  | Item 3. |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 32      
|                             |  |         | 
|                             |  | Item 4. |  | Controls and Procedures                                                               |  | 33      
|                             | 
|Part IIOther Information    |  |        
|                             |  |         | 
|                             |  | Item 2. |  | Changes in Securities and Use of Proceeds                                             |  | 33      
|                             |  |         | 
|                             |  | Item 6. |  | Exhibits and Reports on Form 8-K                                                      |  | 34      
|                             | 
|Signatures                   |  | 34     



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PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



INET TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share data)



|                                                                                                                              |  | September 30, 2003 |         |   | December 31, 2002 |  
|----------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | -
|ASSETS                                                                                                                        |  |                    |         |   |                   |  
|                                                                                                                              |  |                   
|Current assets:                                                                                                               |  |                    |         |   |                   |  
|Cash and cash equivalents                                                                                                     |  | $                  | 168,742 |   |                   | $
|Trade accounts receivable, net of allowance for doubtful accounts of $508 at September 30, 2003 and $484 at December 31,
2002 |  |                    | 7,487   |   |                   |  
|Unbilled receivables                                                                                                          |  |                    | 33      |   |                   |  
|Inventories                                                                                                                   |  |                    | 6,615   |   |                   |  
|Deferred income taxes                                                                                                         |  |                    | 907     |   |                   |  
|Other current assets                                                                                                          |  |                    | 6,999   |   |                   |  
|                                                                                                                              |  |                    |         |   |                   |  
|Total current assets                                                                                                          |  |                    | 190,783 |   |                   |  
|Property and equipment, net                                                                                                   |  |                    | 12,353  |   |                   |  
|Other assets                                                                                                                  |  |                    | 586     |   |                   |  
|                                                                                                                              |  |                    |         |   |                   |  
|Total assets                                                                                                                  |  | $                  | 203,722 |   |                   | $
|                                                                                                                              |  |                    |         |   |                   |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                          |  |                    |         |   |                   |  
|                                                                                                                              |  |                   
|Current liabilities:                                                                                                          |  |                    |         |   |                   |  
|Accounts payable                                                                                                              |  | $                  | 1,761   |   |                   | $
|Accrued compensation and benefits                                                                                             |  |                    | 2,651   |   |                   |  
|Deferred revenues                                                                                                             |  |                    | 19,496  |   |                   |  
|Income taxes payable                                                                                                          |  |                    | 508     |   |                   |  
|Other accrued liabilities                                                                                                     |  |                    | 5,190   |   |                   |  
|                                                                                                                              |  |                    |         |   |                   |  
|Total current liabilities                                                                                                     |  |                    | 29,606  |   |                   |  
|Deferred income taxes                                                                                                         |  |                    | 149     |   |                   |  
|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 September 30, 2003 and 47,157,543 at December 31, 2002              |  |                    | 47      |   |                   |  
|Additional paid-in capital                                                                                                    |  |                    | 76,012  |   |                   |  
|Unearned compensation                                                                                                         |  |                    | (310    | ) |                   |  
|Retained earnings                                                                                                             |  |                    | 131,545 |   |                   |  
|Treasury stock, 8,437,308 common shares at September 30, 2003 and no common shares at December 31, 2002, at cost              |  |                    | (33,327 | ) |                   |  
|                                                                                                                              |  |                    |         |   |                   |  
|Total stockholders equity                                                                                                    |  |                    | 173,967 |   |                   |  
|                                                                                                                              |  |                    |         |   |                   |  
|Total liabilities and stockholders equity                                                                                    |  | $                  | 203,722 |   |                   | $
|                                                                                                                              |  |                    |         |   |                   |  



See accompanying notes
to consolidated financial statements.



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INET TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except per share
data)



|                                         |  | Three months ended September 30, |        |   | Nine months ended September 30,
|---------------------------------------- |  | -------------------------------- | ------ | - | -------------------------------
|                                         |  | 2003                             |        |   | 2002                           
|Revenues:                                |  |                                  |        |   |                                
|Product and license fees                 |  | $                                | 18,072 |   |                                
|Services                                 |  |                                  | 7,962  |   |                                
|                                         |  |                                  |        |   |                                
|Total revenues                           |  |                                  | 26,034 |   |                                
|                                         |  |                                  |        |  
|Cost of revenues:                        |  |                                  |        |   |                                
|Product and license fees                 |  |                                  | 4,717  |   |                                
|Services                                 |  |                                  | 3,743  |   |                                
|                                         |  |                                  |        |   |                                
|Total cost of revenues                   |  |                                  | 8,460  |   |                                
|                                         |  |                                  |        |   |                                
|Gross profit                             |  |                                  | 17,574 |   |                                
|Operating expenses:                      |  |                                  |        |   |                                
|Research and development                 |  |                                  | 7,412  |   |                                
|Sales and marketing                      |  |                                  | 3,889  |   |                                
|General and administrative               |  |                                  | 2,456  |   |                                
|Restructuring costs                      |  |                                  |       |   |                                
|                                         |  |                                  |        |   |                                
|                                         |  |                                  | 13,757 |   |                                
|                                         |  |                                  |        |   |                                
|Income from operations                   |  |                                  | 3,817  |   |                                
|Other income (expense):                  |  |                                  |        |   |                                
|Interest income                          |  |                                  | 290    |   |                                
|Other income (expense)                   |  |                                  | (140   | ) |                                
|                                         |  |                                  |        |   |                                
|                                         |  |                                  | 150    |   |                                
|                                         |  |                                  |        |   |                                
|Income before provision for income taxes |  |                                  | 3,967  |   |                                
|Provision for income taxes               |  |                                  | 1,189  |   |                                
|                                         |  |                                  |        |   |                                
|Net income                               |  | $                                | 2,778  |   |                                
|                                         |  |                                  |        |   |                                
|Earnings per common share:               |  |                                  |        |   |                                
|Basic                                    |  | $                                | 0.07   |   |                                
|                                         |  |                                  |        |   |                                
|Diluted                                  |  | $                                | 0.07   |   |                                
|                                         |  |                                  |        |   |                                
|Weighted-average shares outstanding:     |  |                                  |        |   |                                
|Basic                                    |  |                                  | 38,612 |   |                                
|                                         |  |                                  |        |   |                                
|Diluted                                  |  |                                  | 39,238 |   |                                
|                                         |  |                                  |        |   |                                



See accompanying notes
to consolidated financial statements.



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INET TECHNOLOGIES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

(Unaudited)

(In thousands, except share data)



|                                                                                                             |  | Common Stock |  | AdditionalPaid-inCapital |    | UnearnedCompensation |   |        | RetainedEarnings |   | Treasury Stock |        |  | TotalStockholdersEquity |        
|------------------------------------------------------------------------------------------------------------ |  | ------------ |  | ------------------------ | -- | -------------------- | - | ------ | ---------------- | - | -------------- | ------ |  | ------------------------ | -------
|                                                                                                             |  | Shares       |  | Amount                   |    |                      |   |        | Shares           |   |                | Amount |  |                         
|Balance at December 31, 2002                                                                                 |  | 47,157,543   |  | $                        | 47 |                      | $ | 75,075 |                  | $ | (407           | )      |  | $                        | 123,241
|Repurchase of common stock                                                                                   |  |             |  |                          |   |                      |   |       |                  |   |               |        |  |                          |       
|Issuance of common stock under employee stock option and stock purchase plans, including tax benefit of $483 |  | 2,100        |  |                          |   |                      |   | 937    |                  |   | (109           | )      |  |                          |       
|Net income                                                                                                   |  |             |  |                          |   |                      |   |       |                  |   |               |        |  |                          | 8,304  
|Amortization of restricted stock awards                                                                      |  |             |  |                          |   |                      |   |       |                  |   | 206            |        |  |                          |       
|                                                                                                             |  |              |  |                          |    |                      |   |        |                  |   |                |        |  |                          |        
|Balance at September 30, 2003                                                                                |  | 47,159,643   |  | $                        | 47 |                      | $ | 76,012 |                  | $ | (310           | )      |  | $                        | 131,545
|                                                                                                             |  |              |  |                          |    |                      |   |        |                  |   |                |        |  |                          |        



See accompanying notes
to consolidated financial statements.



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INET TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



|                                                                                                                       |  | Nine months ended September 30, |        
|---------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | -------
|                                                                                                                       |  | 2003                            |        
|Cash flows from operating activities:                                                                                  |  |                                 |        
|Net income                                                                                                             |  | $                               | 8,304  
|Adjustments to reconcile net income to net cash provided by operating activities:                                      |  |                                 |        
|Depreciation                                                                                                           |  |                                 | 5,282  
|Stock compensation                                                                                                     |  |                                 | 206    
|Deferred income taxes                                                                                                  |  |                                 | 74     
|Changes in operating assets and liabilities:                                                                           |  |                                 |        
|Decrease in trade accounts receivable                                                                                  |  |                                 | 2,724  
|Decrease in unbilled receivables                                                                                       |  |                                 | 122    
|Decrease in income taxes receivable                                                                                    |  |                                 |       
|Decrease in inventories                                                                                                |  |                                 | 843    
|Increase in other assets                                                                                               |  |                                 | (2,376 
|Increase in accounts payable                                                                                           |  |                                 | 683    
|Decrease in taxes payable                                                                                              |  |                                 | (962   
|Increase (decrease) in accrued compensation and benefits                                                               |  |                                 | (1,462 
|Increase (decrease) in deferred revenues                                                                               |  |                                 | 1,173  
|Increase in other accrued liabilities                                                                                  |  |                                 | 957    
|                                                                                                                       |  |                                 |        
|Net cash provided by operating activities                                                                              |  |                                 | 15,568 
|                                                                                                                       |  |                                
|Cash flows from investing activities:                                                                                  |  |                                 |        
|Purchases of property and equipment                                                                                    |  |                                 | (2,920 
|                                                                                                                       |  |                                 |        
|Net cash used in investing activities                                                                                  |  |                                 | (2,920 
|                                                                                                                       |  |                                
|Cash flows from financing activities:                                                                                  |  |                                 |        
|Repurchase of common stock                                                                                             |  |                                 | (35,553
|Proceeds from issuance of common stock upon exercise of stock options and purchases under employee stock purchase
plan |  |                                 | 2,571  
|                                                                                                                       |  |                                 |        
|Net cash provided by (used in) financing activities                                                                    |  |                                 | (32,982
|                                                                                                                       |  |                                 |        
|Net (decrease) increase in cash and cash equivalents                                                                   |  |                                 | (20,334
|Cash and cash equivalents at beginning of period                                                                       |  |                                 | 189,076
|                                                                                                                       |  |                                 |        
|Cash and cash equivalents at end of period                                                                             |  | $                               | 168,742
|                                                                                                                       |  |                                 |        
|Supplemental disclosure:                                                                                               |  |                                 |        
|Income taxes paid                                                                                                      |  | $                               | 2,542  
|                                                                                                                       |  |                                 |        



See accompanying notes
to consolidated financial statements.



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INET TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Note 1Summary of Significant Accounting Policies



The Company



Inet Technologies, Inc. is a global provider of communications software products that enable communications carriers to more strategically and profitably operate their businesses. Our Unified Assurance Solution and our Diagnostics products
help our customers reduce capital and operating expenditures, improve customer acquisition and retention rates, protect and grow revenues, and more quickly and effectively develop products or services. Our products address next-generation networks,
including mobile data and voice-over-packet technologies, and traditional networks.



Using our Unified Assurance Solution, which includes the GeoProbe, Orion and Beamer products, communications carriers are able to simultaneously manage their voice and data services at the network, service and
customer layers to detect network and service problems in real time, enabling proactive identification of specific customers impacted by network or service issues. These products capture actual signaling network traffic and then process, correlate
and analyze the traffic data to create and display customer experience information, service quality metrics and a network-wide view. This information empowers a carriers customer service, sales, marketing and network operations organizations
to proactively manage the quality of service delivered to its most valuable customers. These products also alert the carrier to network problems, such as congestion, misrouted calls due to equipment errors and service degradation, so that action can
be taken to quickly resolve issues, often before its customers are impacted and significant revenue is lost. Our Diagnostics products include the Spectra2, Spectra and Spectra Trunk Tester, which assist communications carriers and equipment
manufacturers in quickly and cost-effectively designing, deploying and maintaining current- and next-generation networks and network elements.



Consolidation



The consolidated financial statements include the accounts of our wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated.



Unaudited Interim Financial Statements



We have prepared the accompanying unaudited
consolidated financial statements in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these statements do
not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In our opinion, all adjustments (consisting solely of normal recurring adjustments)
necessary for a fair statement of the results for the interim periods presented have been included. These financial statements should be read in conjunction with the audited financial statements and related notes for the three years ended December
31, 2002 included in our Form 10-K filed with the Securities and Exchange Commission, or SEC, on February 28, 2003. Operating results for the three- and nine-month periods ended September 30, 2003 are not necessarily indicative of the results that
may be expected for any other interim period or for the year ending December 31, 2003.



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Accounting Estimates



The preparation of financial statements in conformity with generally accepted accounting principles requires us to make
estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. As discussed below, we make significant estimates and assumptions in the areas of accounts receivable, inventories, revenue recognition
and taxes. Although we believe that our estimates and assumptions are reasonable, actual results may differ, and such differences could be significant to our financial results.



Basis of Presentation



Certain prior period amounts have been reclassified to conform to the current period presentation.



Cash and Cash Equivalents



Cash and cash equivalents consist of bank deposits and money-market funds.
All highly-liquid securities with original maturities of three months or less are classified as cash equivalents. The carrying value of cash equivalents approximates fair market value.



Allowance for Doubtful Accounts



A large portion of our revenues and accounts receivable are attributable to our carrier customers in the communications
industry and, to a lesser extent, to our equipment manufacturer customers who supply equipment into the communications industry. Our trade accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our
customers. Because our accounts receivable are usually unsecured, we periodically evaluate the collectibility of our accounts based on a combination of factors, including a particular customers ability to pay and the 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 other information provided by the customer, or third-party credit analysis reports or other publicly-available
information. In cases where the evidence suggests a customer may not be able to satisfy its obligations to us, we set up a specific reserve in an amount we determine appropriate for the perceived risk. Most of our contracts include multiple payment
milestones, some of which occur in advance of revenue recognition, which mitigates our risk both in terms of collectibility and adjustments to recorded revenue. Given that most of our customers are large public companies with substantial resources,
we have not historically experienced significant losses on uncollectible accounts and our allowance has been less than 5% of recorded receivables. If the current downturn in the communications industry continues, the financial condition of our
customers could deteriorate and they may not be able to meet their financial obligations to us. If this were to occur, the net value realized from our receivables may be materially different from the net balance recorded on our balance sheet.



Inventories



Inventories are valued at the lower of standard cost, which approximates
actual cost determined on a first-in, first-out basis, or market. At September 30, 2003 and December 31, 2002, inventories consisted of the following (in thousands):



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|                |  | September 30, 2003 |       | December 31, 2002
|--------------- |  | ------------------ | ----- | -----------------
|Raw materials   |  | $                  | 2,856 |                  
|Work-in-process |  |                    | 90    |                  
|Finished goods  |  |                    | 3,669 |                  
|                |  |                    |       |                  
|                |  | $                  | 6,615 |                  
|                |  |                    |       |                  



Inventories are
recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate on a quarterly basis the status of our inventory to ensure the amount recorded in our financial statements reflects the lower of our
cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the condition and salability of our inventory and the forecasted demand for the particular products incorporating these
components. Based on current backlog and expected orders, we forecast the upcoming usage of current stock. We record reserves for obsolete and slow-moving parts of up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in
work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk.



Revenue Recognition



We derive revenues primarily from product and license fees as well as services, which include training, warranty and product support services. The
majority of the contracts for our GeoProbe, Orion and Beamer products contain multiple billing milestones, such as contract award, shipment, installation and acceptance, not all of which are associated with revenue recognition. Except as otherwise
discussed below, revenues from product and license fees are recognized in the period that we have completed all hardware manufacturing and/or software development to contractual specifications, factory testing has been completed, the product has
been shipped to the customer, the fee is fixed and determinable and collection of the fee is considered probable. When we have significant obligations subsequent to shipment, such as installation and system integration, revenues are recognized when
there are no significant unfulfilled obligations. Revenues from arrangements that include significant acceptance terms and/or provisions are recognized when acceptance has occurred. Revenues from our Diagnostics products are typically recognized
when title and risk of loss pass to the customer, which typically occurs at shipment. For these products, we typically 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 of revenues in our consolidated statements of income.



Contracts for our GeoProbe, Orion and Beamer products are typically multiple-element arrangements, which means they involve multiple deliverables. We
determine the fair value of each of the contract deliverables using vendor-specific objective evidence, or VSOE. VSOE for each element is based on the price for which we would sell the element on a stand-alone basis. We offer our customers product
support services, which include the correction of software problems, telephone access to our technical personnel and the right to receive unspecified product updates, upgrades and enhancements, when and if they become available. Revenues from these
services, including post-contract support included in initial licensing fees, are recognized ratably over the contract period. Post-contract support included in the initial licensing fee are allocated from the total contract amount based on the fair
value of these services determined using VSOE. Revenues from other services, such as training, are recognized when the services have been completed.



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



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Income Taxes



Our income taxes are computed using the asset and liability method of accounting. Under the asset and liability method, a
deferred tax asset or liability is recognized for estimated future tax effects attributable to temporary differences and carryforwards.



In the preparation of our provision for income taxes and determination of whether deferred tax assets will be realized in full or in part, we must
estimate several factors. When it is more likely than not that all or some portion of the deferred tax asset will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that is determined not to be
realizable. As of September 30, 2003 and September 30, 2002, a valuation for deferred tax assets was not deemed necessary. If the facts or financial results on which our estimates are based were to change, thereby impacting the likelihood of
realizing the deferred tax assets, judgment would have to be applied to determine the amount of valuation allowance required in any given period. Additionally, our income tax returns are subject to review and examination in the various jurisdictions
in which we operate. We are currently not aware of any issues that have been raised by taxing jurisdictions, and management believes that all income tax issues which may be raised as a result of such reviews and examinations in the future will be
resolved with no material impact on our financial position or future results of operations. However, in the event there was an assessment by any of these jurisdictions, it could impact our tax provision.



Stock Options



We have elected to follow Accounting Principles Board, or APB, Opinion No.
25, Accounting for Stock Issued to Employees, in accounting for our employee stock options. Under APB 25, if the exercise price of an employees stock options equals or exceeds the market price of the underlying stock on the date of
grant, no compensation expense is recognized. At September 30, 2003, we had three stock-based compensation plans covering employees and directors. We account for stock-based compensation for non-employees under the fair value method prescribed by
Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation. Through September 30, 2003, there have been no grants to non-employees other than grants to our non-employee directors under our automatic
option grant program. As of September 30, 2003, unearned stock compensation related to restricted stock grants was approximately $0.3 million. We had no unearned stock compensation at September 30, 2002.



Although SFAS 123 allows us to continue to follow the present APB 25
guidelines in accounting for employee stock options and employee stock purchase rights, we are required to disclose pro forma net income (loss) and net income (loss) per share as if we had adopted SFAS 123 in accounting for employee stock options
and restricted stock issuances and employee stock purchase rights. The pro forma impact of applying SFAS 123 in the three and nine months ended September 30, 2003 and the three and nine months ended September 30, 2002 will not necessarily be
representative of the pro forma impact in future periods. Our pro forma information is as follows (in thousands, except per share data):



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|                                                                                               |  | Three months ended September 30, |        |   | Nine months ended September 30, |  
|---------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | -
|                                                                                               |  | 2003                             |        |   | 2002                            |  
|Net income, as reported                                                                        |  | $                                | 2,778  |   |                                 | $
|Stock compensation expense recorded under the intrinsic value method, net of income taxes      |  |                                  | 25     |   |                                 |  
|Pro forma stock compensation expense computed under the fair value method, net of income taxes |  |                                  | (1,083 | ) |                                 |  
|                                                                                               |  |                                  |        |   |                                 |  
|Pro forma net income (loss)                                                                    |  | $                                | 1,720  |   |                                 | $
|                                                                                               |  |                                  |        |   |                                 |  
|Basic earnings per common share, as reported                                                   |  | $                                | 0.07   |   |                                 | $
|                                                                                               |  |                                  |        |   |                                 |  
|Diluted earnings per common share, as reported                                                 |  | $                                | 0.07   |   |                                 | $
|                                                                                               |  |                                  |        |   |                                 |  
|Pro forma basic earnings (loss) per common share                                               |  | $                                | 0.04   |   |                                 | $
|                                                                                               |  |                                  |        |   |                                 |  
|Pro forma diluted earnings (loss) per common share                                             |  | $                                | 0.04   |   |                                 | $
|                                                                                               |  |                                  |        |   |                                 |  



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



|                                               |  | Three months ended September 30, |      |   | Nine months ended September 30, |  
|---------------------------------------------- |  | -------------------------------- | ---- | - | ------------------------------- | -
|                                               |  | 2003                             |      |   | 2002                            |  
|Volatility                                     |  |                                  | 0.92 |   |                                 |  
|Weighted-average expected lives                |  |                                  | 3.69 |   |                                 |  
|Expected dividend yields                       |  |                                  |     |   |                                 |  
|Weighted-average risk-free interest rates      |  |                                  | 2.73 | % |                                 |  
|Weighted-average fair value of options granted |  | $                                | 7.94 |   |                                 | $



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



|                                                              |  | Three months ended September 30, |      |   | Nine months ended September 30, |  
|------------------------------------------------------------- |  | -------------------------------- | ---- | - | ------------------------------- | -
|                                                              |  | 2003                             |      |   | 2002                            |  
|Volatility                                                    |  |                                  | 0.95 |   |                                 |  
|Weighted-average expected lives                               |  |                                  | 0.50 |   |                                 |  
|Expected dividend yields                                      |  |                                  |     |   |                                 |  
|Weighted-average risk-free interest rates                     |  |                                  | 1.18 | % |                                 |  
|Weighted-average fair value of employee stock purchase rights |  | $                                | 3.78 |   |                                 | $



Note 2Related Party
Transactions



On January 21, 2003, we repurchased in a
privately-negotiated transaction 8,969,984 restricted shares of our common stock from Mark A. Weinzierl, one of our founders and a member of our board of directors



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until the closing of the transaction, for an aggregate cash purchase price of approximately $35.4 million. We funded the transaction with available cash. The
shares repurchased represented approximately 19% of our total shares outstanding immediately prior to the transaction. Effective as of the closing of the transaction, Mr. Weinzierl resigned from our board of directors.



Epygi Technologies, Ltd., an entity controlled by Samuel S. Simonian, one of
our founders and chairman of our board, currently performs development services for us pursuant to a consulting agreement for which it is paid a monthly fee per full-time programmer plus reimbursement of reasonable business expenses. We expensed
approximately $0.1 million for these services in the three months ended September 30, 2003 and approximately $0.3 million for these services in the three months ended September 30, 2002. We expensed approximately $0.3 million for these services in
the nine months ended September 30, 2003 and approximately $0.8 million for these services in the nine months ended September 30, 2002.



Note 3Restructuring



We recorded a restructuring charge for the three months ended September 30, 2002 of approximately $0.4 million related primarily to a workforce reduction
of approximately 35 employees. The reduction affected all areas of the company. The charge consisted primarily of employee severance of approximately $0.3 million and professional fees and outplacement services of approximately $0.1 million. At
September 30, 2003, the balance of these costs that remained to be paid was less than $0.1 million.



Note 4Earnings Per Share



The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):



|                                                                            |  | Three months ended September 30, |        | Nine months ended September 30,
|--------------------------------------------------------------------------- |  | -------------------------------- | ------ | -------------------------------
|                                                                            |  | 2003                             |        | 2002                           
|Numerator:                                                                  |  |                                  |        |                                
|Net income for basic and diluted earnings per share                         |  | $                                | 2,778  |                                
|                                                                            |  |                                  |        |                                
|Denominator:                                                                |  |                                  |        |                                
|Denominator for basic earnings per shareweighted-average shares            |  |                                  | 38,612 |                                
|Dilutive securities: Employee stock options and purchase rights             |  |                                  | 626    |                                
|                                                                            |  |                                  |        |                                
|Denominator for diluted earnings per shareadjusted weighted-average shares |  |                                  | 39,238 |                                
|                                                                            |  |                                  |        |                                
|Basic earnings per common share                                             |  | $                                | 0.07   |                                
|                                                                            |  |                                  |        |                                
|Diluted earnings per common share                                           |  | $                                | 0.07   |                                
|                                                                            |  |                                  |        |                                



Note 5Segment Information



We operate in a single industry segment, providing
communications software solutions and associated services to our customers through our sales personnel and certain foreign resellers. As a result, the financial information disclosed in this report represents all material financial information
related to our sole operating segment. The geographic distribution of our revenues as a percentage of total revenues is as follows:



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|                               |  | Three months ended September 30, |   |  | Nine months ended September 30, |  
|------------------------------ |  | -------------------------------- | - |  | ------------------------------- | -
|                               |  | 2003                             |   |  | 2002                            |  
|United States                  |  | 36.8                             | % |  | 34.0                            | %
|Export:                        |  |                                  |   |  |                                 |  
|Asia/Pacific                   |  | 8.2                              |   |  | 5.3                             |  
|Europe, Middle East and Africa |  | 53.5                             |   |  | 58.9                            |  
|Other                          |  | 1.5                              |   |  | 1.8                             |  
|                               |  |                                  |   |  |                                 |  
|Total export                   |  | 63.2                             |   |  | 66.0                            |  
|                               |  |                                  |   |  |                                 |  
|                               |  | 100.0                            | % |  | 100.0                           | %
|                               |  |                                  |   |  |                                 |  



In the three months
ended September 30, 2003, revenues from one domestic wireline customer accounted for approximately 21% of total revenues, revenues from one international wireline customer accounted for approximately 18% of total revenues and revenues from another
international wireline customer accounted for approximately 18% of total revenues. In the three months ended September 30, 2002, revenues from one international wireline customer accounted for approximately 16% of total revenues and revenues from
another international wireline customer accounted for approximately 14% of total revenues. In the nine months ended September 30, 2003, revenues from one international wireline customer accounted for approximately 22% of total revenues. In the nine
months ended September 30, 2002, revenues from one international wireline customer accounted for approximately 21% of total revenues.



We have no significant long-lived assets deployed outside of the United States.



Note 6Recent Accounting Pronouncements



In July 2002, the Financial Accounting Standards Board, or FASB, issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This statement nullifies Emerging Issues Task Force, or EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring). The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. This statement is applicable
to exit or disposal activities initiated after December 31, 2002. The adoption of this standard did not have a significant effect on our financial position or results of operations.



Note 7Subsequent Event



In October 2003, we completed an underwritten 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 the proceeds from the sale of common stock. We effected the offering
pursuant to a demand made by the selling stockholders in accordance with rights granted to them under a registration rights agreement dated July 23, 1998. We are paying all of the expenses of the offering incurred by us and certain fees and expenses
of the selling stockholders, excluding underwriting discounts and commissions. At September 30, 2003, we had expensed approximately $0.3 million of accounting, legal and professional fees and anticipate additional expenses of approximately $0.1
million in the fourth quarter of 2003.



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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



Forward-Looking Statements



This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than historical or current facts, including, without limitation, statements about our business strategy, plans and objectives of management and our future
prospects, are forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are reasonable, such forward-looking statements are subject to risks and uncertainties that could cause actual results
to differ materially from these expectations. Such risks and uncertainties include, without limitation, the following:



| |  | Our operating results are difficult to predict and are likely to vary significantly from quarter to quarter in the future;
| | - | --------------------------------------------------------------------------------------------------------------------------



| |  | We could be materially harmed in the event of a continued general economic slowdown, reduced spending by communications carriers and equipment manufacturers or consolidations or
bankruptcies involving our current or prospective customers;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We could be materially harmed if demand for our products and applications is less than we anticipate;
| | - | -----------------------------------------------------------------------------------------------------



| |  | We could be materially harmed if the market for current- and next-generation network products and applications fails to develop as we currently anticipate;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Expected increased competition could result in further price reductions and reduced margins, as well as loss of market share; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| |  | Other risks indicated below under the caption Risk Factors.
| | - | -------------------------------------------------------------



These risks and uncertainties are beyond our control and, in many cases, we cannot predict the risks and uncertainties
that could cause our actual results to differ materially from those indicated by the forward-looking statements. 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 and similar expressions as they
relate to us or our management are intended to identify forward-looking statements.



The following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report and the
consolidated financial statements and notes thereto and Managements Discussion and Analysis of Financial Condition and Results of Operations in our Form 8-K filed with the SEC on September 18, 2003. Historical results and percentage
relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.



Overview



Inet Technologies, Inc. is a global provider of communications software products that enable communications carriers to more strategically and profitably
operate their businesses. Our Unified Assurance Solution and our Diagnostics products help our customers reduce capital and operating expenditures, improve customer acquisition and retention rates, protect and grow revenues, and more quickly and
effectively develop products or services. Our products address next-generation networks, including mobile data and voice-over-packet technologies, and traditional networks.



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Using our Unified Assurance Solution, which includes the GeoProbe, Orion and Beamer products,
communications carriers are able to simultaneously manage their voice and data services at the network, service and customer layers to detect network and service problems in real time, enabling proactive identification of specific customers impacted
by network or service issues. These products capture actual signaling network traffic and then process, correlate and analyze the traffic data to create and display customer experience information, service quality metrics and a network-wide view.
This information empowers a carriers customer service, sales, marketing and network operations organizations to proactively manage the quality of service delivered to its most valuable customers. These products also alert the carrier to
network problems, such as congestion, misrouted calls due to equipment errors and service degradation, so that action can be taken to quickly resolve issues, often before its customers are impacted and significant revenue is lost. Our Diagnostics
products include the Spectra2, Spectra and Spectra Trunk Tester, which assist communications carriers and equipment manufacturers in quickly and cost-effectively designing, deploying and maintaining current- and next-generation networks and network
elements.



Results of Operations



The following table sets forth, for the periods presented, certain data
derived from our unaudited consolidated statements of income expressed as a percentage of total revenues. The operating results for the three and nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected
for any future periods.



|                                         |  | Three months ended September 30, |   |  | Nine months ended September 30, |  
|---------------------------------------- |  | -------------------------------- | - |  | ------------------------------- | -
|                                         |  | 2003                             |   |  | 2002                            |  
|Revenues:                                |  |                                  |   |  |                                 |  
|Product and license fees                 |  | 69.4                             | % |  | 71.5                            | %
|Services                                 |  | 30.6                             |   |  | 28.5                            |  
|                                         |  |                                  |   |  |                                 |  
|Total revenues                           |  | 100.0                            |   |  | 100.0                           |  
|Cost of revenues:                        |  |                                  |   |  |                                 |  
|Product and license fees                 |  | 18.1                             |   |  | 30.1                            |  
|Services                                 |  | 14.4                             |   |  | 13.0                            |  
|                                         |  |                                  |   |  |                                 |  
|Total cost of revenues                   |  | 32.5                             |   |  | 43.1                            |  
|Gross Profit:                            |  |                                  |   |  |                                 |  
|Product and license fees                 |  | 51.3                             |   |  | 41.4                            |  
|Services                                 |  | 16.2                             |   |  | 15.5                            |  
|                                         |  |                                  |   |  |                                 |  
|Total gross profit                       |  | 67.5                             |   |  | 56.9                            |  
|Operating expenses:                      |  |                                  |   |  |                                 |  
|Research and development                 |  | 28.5                             |   |  | 30.3                            |  
|Sales and marketing                      |  | 14.9                             |   |  | 15.7                            |  
|General and administrative               |  | 9.4                              |   |  | 7.9                             |  
|Restructuring costs                      |  |                                 |   |  | 1.0                             |  
|                                         |  |                                  |   |  |                                 |  
|Total operating expenses                 |  | 52.8                             |   |  | 54.9                            |  
|                                         |  |                                  |   |  |                                 |  
|Income from operations                   |  | 14.7                             |   |  | 2.0                             |  
|Other income                             |  | 0.6                              |   |  | 2.7                             |  
|                                         |  |                                  |   |  |                                 |  
|Income before provision for income taxes |  | 15.3                             |   |  | 4.7                             |  
|Provision for income taxes               |  | 4.6                              |   |  | 1.2                             |  
|                                         |  |                                  |   |  |                                 |  
|Net income                               |  | 10.7                             | % |  | 3.5                             | %
|                                         |  |                                  |   |  |                                 |  



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Revenues



Product and license fees.Revenues from product and license fees increased 9.1% to $18.1 million in the three months
ended September 30, 2003 from $16.6 million in the three months ended September 30, 2002. The increase reflects the contribution of approximately $14.8 million of total revenues by three 10% customers in the three months ended September 30, 2003
compared to the contribution of approximately $7.0 million of total revenues by two 10% customers in the same prior-year period. Revenues from each of the three 10% customers in the current quarter related to major expansions of existing systems,
which were more extensive than typical system expansions.



In
the nine months ended September 30, 2003, revenues from product and license fees decreased 6.1% to $53.4 million from $56.8 million in the nine months ended September 30, 2002. The decline in revenues from product and license fees was primarily
attributable to continued pressure on sales prices for our GeoProbe product, especially for those applications for which there is a competitive offering and in highly competitive situations involving prospective customers. We believe prices for our
most basic network assurance GeoProbe applications have decreased by approximately 15% to 20%. We anticipate that we will continue to experience pricing pressures for our GeoProbe product although not to the same extent as in the last several
quarters.



Services. Revenues from services increased
20.9% to $8.0 million in the three months ended September 30, 2003 from $6.6 million in the three months ended September 30, 2002. In the nine months ended September 30, 2003, revenues from services increased 15.6% to $23.2 million from $20.1
million in the nine months ended September 30, 2002. In the nine months ended September 30, 2003 compared to the same prior year period, the increase in services revenues was primarily attributable to providing support services to six additional
Unified Assurance customers and to supporting a larger installed base of products with existing customers for which we provide warranty or product support services. Going forward, we expect to sell additional applications to, or expand the footprint
of our products with existing customers, and to add new customers, which should continue to increase our installed base of products and corresponding services revenues; however, we expect that continued pressure on prices for product support
renewals may partially offset the effect of this anticipated increase.



Concentration of revenues. In the three months ended September 30, 2003, revenues from one domestic wireline customer accounted for approximately 21% of total revenues, revenues from one international wireline customer accounted for
approximately 18% of total revenues and revenues from another international wireline customer accounted for approximately 18% of total revenues. In the three months ended September 30, 2002, revenues from one international wireline customer
accounted for approximately 16% of total revenues and revenues from another international wireline customer accounted for approximately 14% of total revenues. In the nine months ended September 30, 2003, revenues from one international wireline
customer accounted for approximately 22% of total revenues. In the nine months ended September 30, 2002, revenues from one international wireline customer accounted for approximately 21% of total revenues. A large percentage of our revenues are
typically derived from a small number of customers, the specific make up of which typically varies from one quarter to the next. On a quarterly basis, the 10 largest customers for the quarter typically account for approximately 50% to 80% of total
revenues. For the three months ended September 30, 2003, approximately 71% of our revenues were derived from the 10 largest customers for that period. For the nine months ended September 30, 2003, approximately 61% of our revenues were derived from
the 10 largest customers for that period. We expect these trends to continue for the foreseeable future.



International revenues. In the three months ended September 30, 2003, international revenues accounted for approximately 63% of total revenues
compared to approximately 66% of total revenues in the three months ended September 30, 2002. In the nine months ended September 30, 2003, international revenues



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accounted for approximately 72% of total revenues compared to approximately 73% of total revenues in the nine months ended September 30, 2002. Variations in
the percentage of total revenues derived from international markets may occur as a result of the concentration of revenues in a particular period from a small number of customers and the economic conditions in the regions in which we operate. For
the remainder of 2003, we expect revenues from international markets to represent a substantial majority of our total revenues.



Cost of Revenues



Product and license fees.Cost of product and license fees consists primarily of hardware, personnel and overhead expenses related to the
manufacturing, integration and installation of our products. Cost of product and license fees was $4.7 million, or 26.1% of product and license fees revenues, in the three months ended September 30, 2003, and $7.0 million, or 42.1% of product and
license fees revenues, in the three months ended September 30, 2002. The decrease in the cost of product and license fees is primarily driven by the relatively higher software-based content in our product implementations and the economies of scale
benefit from the increase in product and license fees revenues. The major components of the decreases in absolute dollars and as a percentage of product and license fees were decreased hardware costs of approximately $0.5 million, decreased costs of
approximately $0.6 million associated with excess or obsolete inventory and decreased costs of approximately $0.3 million associated with standard price changes, which involved valuing our inventory at market. In the three months ended September 30,
2003 we utilized inventory previously identified as excess, which reduced our reserve for excess inventory by approximately $0.3 million, and we had no significant charges for standard price changes. In the three months ended September 30, 2002 we
increased our inventory reserve by approximately $0.3 million for excess and obsolete inventory and had a charge to cost of product and license fees of approximately $0.3 million for standard price changes.



Cost of product and license fees was $14.0 million, or 26.1% of product and
license fees revenues, in the nine months ended September 30, 2003, and $21.2 million, or 37.3% of product and license fees revenues, in the nine months ended September 30, 2002. The decrease in the cost of product and license fees is primarily
driven by the relatively higher software-based content of our product implementations experienced in the first nine months of the year. The major components of the decreases in absolute dollars and as a percentage of product and license fees
revenues were decreased hardware costs of approximately $3.8 million and decreased costs of approximately $0.7 million associated with excess or obsolete inventory. We utilized inventory previously identified as excess, which reduced our reserve for
excess inventory by $0.4 million, compared to an increase to the reserve for excess inventory of approximately $0.4 million in the nine months ended September 30, 2002. We also had absorption of $0.6 million of labor and overhead expenses to
inventory.



Services. Cost of services consists of
expenses, primarily personnel costs, related to our product support, training and warranty and non-warranty services activities. Cost of services was $3.7 million, or 47.0% of services revenues, in the three months ended September 30, 2003, and $3.0
million, or 45.7% of services revenues, in the three months ended September 30, 2002. Cost of services was $11.2 million, or 48.4% of services revenues, in the nine months ended September 30, 2003, and $9.5 million, or 47.2% of services revenues, in
the nine months ended September 30, 2002. For both the three- and nine-month periods ended September 30, 2003 compared to the same periods of the prior year, the increase in absolute dollars is attributable to increased efforts to support a larger
installed base of products and increased expenses related to customer support and systems engineering. Historically, cost of services as a percentage of services revenues has fluctuated as a result of the relative mix of product support, training
and warranty and non-warranty service activities during a specific period. We expect these fluctuations to continue into the foreseeable future.



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Operating Expenses



Research and development expenses. Research and development expenses consist primarily of personnel expenses and
contract labor, travel and facilities expenses incurred by our research and development organization. Our research and development efforts include expenditures relating to new products and applications, and new features or enhancements for existing
products, primarily in the areas of next-generation wireless and packet-based technologies. These expenses were $7.4 million in the three months ended September 30, 2003 and $7.0 million in the three months ended September 30, 2002. Research and
development expenses as a percentage of total revenues were 28.5% in the three months ended September 30, 2003 and 30.3% in the three months ended September 30, 2002. As a percentage of total revenues, research and development expenses decreased
primarily due to the increase in total revenues.



In the nine
months ended September 30, 2003, research and development expenses decreased to $22.4 million from $22.8 million for the comparable prior-year period. Research and development expenses as a percentage of total revenues were 29.2% for the nine months
ended September 30, 2003 and 29.6% for the nine months ended September 30, 2002. The decrease in absolute dollars was attributable to decreased staffing dedicated to research and development activities and, to a lesser extent, decreased use of
third-party research and development services, which was approximately $0.3 million lower in the nine months ended September 30, 2003 compared to the same period in the prior year, partially offset by increases in various other expense categories.
The average headcount of our research and development organization was 245 in the nine months ended September 30, 2003 compared to 268 in the nine months ended September 30, 2002. We do not currently expect to decrease our research and development
headcount from our current staffing level. Overall, we anticipate that spending on research and development in terms of absolute dollars will be flat or increase slightly in the last quarter of 2003.



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



Sales and marketing expenses.Sales and marketing expenses consist primarily of expenses associated with personnel, including commissions from direct sales, travel, facilities and marketing, such as trade show and advertising
expenses. These expenses increased to $3.9 million in the three months ended September 30, 2003 from $3.6 million in the three months ended September 30, 2002. Sales and marketing expenses as a percentage of total revenues were 14.9% in the three
months ended September 30, 2003 and 15.7% in the three months ended September 30, 2002. The increase in absolute dollars was primarily attributable to increased expenses related to tradeshows and other promotional activities.



Sales and marketing expenses decreased to $11.0 million in the nine months
ended September 30, 2003 from $12.5 million for the nine months ended September 30, 2002. Sales and marketing expenses as a percentage of total revenues were 14.4% for the nine months ended September 30, 2003, and 16.3% for the nine months ended
September 30, 2002. The decreases in absolute dollars and as a percentage of total revenues were attributable to decreased average headcount dedicated to sales and marketing activities and cost reduction efforts primarily related to travel, which
decreased approximately $0.2 million. The average headcount of our sales and marketing organization was 67 in the nine months ended September 30, 2003, compared to 77 in the nine months ended September 30, 2002. In the current quarter, we increased
sales and marketing headcount slightly and we currently expect to continue to increase our sales and marketing headcount over the next several quarters. We anticipate that sales and marketing expenses will increase slightly in the last quarter of
the year, and that going forward spending on sales and



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marketing may fluctuate quarter to quarter due to seasonal spending on tradeshows, other promotional activities and the level of direct sales commissions.



General and administrative expenses.General and
administrative expenses consist primarily of personnel, facilities and legal and professional expenses of our finance, legal and executive departments. These expenses were $2.5 million in the three months ended September 30, 2003 and $1.8 million
the three months ended September 30, 2002. General and administrative expenses as a percentage of total revenues were 9.4% in the three months ended September 30, 2003 and 7.9% in the three months ended September 30, 2002. The increases in absolute
dollars and as a percentage of total revenues were primarily attributable to increased accounting, legal and professional fees of approximately $0.4 million of which approximately $0.3 million related to a secondary public stock offering completed
in October 2003.



General and administrative expenses
increased to $6.9 million in the nine months ended September 30, 2003 from $6.0 million in the nine months ended September 30, 2002. General and administrative expenses as a percentage of total revenues were 9.0% for the nine months ended September
30, 2003 and 7.8% for the nine months ended September 30, 2002. The increases in absolute dollars and as a percentage of total revenues were attributable to increased accounting, legal and professional fees of approximately $0.6 million primarily
related to our repurchase of restricted common stock in January 2003 and a secondary public stock offering completed in October 2003. We expect that general and administrative expenses will remain flat or will slightly decrease in the last quarter
of 2003.



Restructuring. We recorded a restructuring
charge for the three months ended September 30, 2002 of approximately $0.4 million related primarily to a workforce reduction of approximately 35 employees. The reduction affected all areas of the company. The charge consisted primarily of employee
severance of approximately $0.3 million and professional fees and outplacement services of approximately $0.1 million. At September 30, 2003, the balance of these costs that remained to be paid was less than $0.1 million.



Other Income (Expense)



Other income consists of interest income earned on our cash and cash
equivalents partially offset by foreign translation adjustments and losses on the disposal of assets. Other income was $0.2 million in the three months ended September 30, 2003, compared to $0.6 million in the three months ended September 30, 2002.
The decrease was primarily attributable to the overall decrease in interest rates received on our investments, lower average cash balances resulting from our repurchase of restricted common stock in January 2003 and foreign translation adjustments.
In the three months ended September 30, 2003, we recognized a return on our average cash balance of 0.7% per annum compared to 1.6% per annum in the same prior-year period. In the three months ended September 30, 2003, we recorded a foreign
translation loss of $0.1 million compared to a foreign translation gain of $0.4 million in the same prior-year period. Foreign translation gains or losses primarily arise from translation adjustments for our international operations, including the
United Kingdom and German sales and support organizations and, to a lesser extent, to the small percentage of business denominated in non-U.S. currencies. Currently, we do not engage in hedging activities for our international operations or our
non-US dollar business.



Other income was $0.8 million in the
nine months ended September 30, 2003, compared to $2.2 million in the nine months ended September 30, 2002. The decrease was primarily attributable to the overall decrease in interest rates received on our investments, lower average cash balances
resulting from our repurchase of restricted common stock in January 2003, and foreign translation adjustments. In the nine months ended September 30, 2003, we recognized a return on our average cash balance of 0.6% per annum compared to 1.2% per
annum in the same prior-year period. In the nine months ended September 30, 2003, we recorded a foreign translation loss of $0.2 million compared to a foreign translation gain of $0.2 million in the same prior-year period.



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Provision for Income Taxes



We recorded an income tax expense of $1.2 million for the three months ended September 30, 2003 compared to $0.3 million for
the three months ended September 30, 2002. Our effective tax rates for these periods were 30.0% for the three months ended September 30, 2003 and 25.0% for the three months ended September 30, 2002. We recorded an income tax expense of $3.6 million
for the nine months ended September 30, 2003 compared to $2.1 million for the nine months ended September 30, 2002. Our effective tax rates for these periods were 30.3% for the nine months ended September 30, 2003 and 30.0% for the nine months ended
September 30, 2002. Federal income taxes for the periods presented have been calculated on the basis of an estimated annual rate. Our effective tax rate differs from the U.S. statutory rate primarily due to the extra-territorial income tax benefit
and utilization of the research and development tax credit. For 2003, we currently anticipate our effective tax rate to be approximately 30.3%.



Our financial statements reflect net deferred tax assets of $0.8 million as of September 30, 2003, comprised of credit carryforwards and deductible
temporary differences. Although realization is not assured, we have concluded that it is more likely than not that the net deferred tax assets will be realized based on the scheduling of deferred tax liabilities and projected taxable income. The
amount of the net deferred tax assets actually realized, however, could vary if there are differences in the timing or amount of future reversals of existing deferred tax liabilities or changes in the actual amounts of future taxable income.



Liquidity and Capital Resources



Since our inception, we have funded our operations and met our capital
expenditure requirements primarily through cash flows from operations and, to a lesser extent during our initial years of operations, through bank borrowings. Our working capital decreased approximately 12% to $161.2 million at September 30, 2003
from $182.5 million at December 31, 2002. We had $168.7 million in cash and cash equivalents at September 30, 2003, a decrease of $20.3 million from $189.1 million in cash and cash equivalents at December 31, 2002. The decreases in cash and working
capital are primarily attributable to our funding of a privately-negotiated transaction that closed on January 21, 2003, under which we repurchased 8,969,984 restricted shares of common stock from Mark Weinzierl, one of our founders, for an
aggregate cash purchase price of approximately $35.4 million.



Net cash provided by operating activities decreased approximately 7% to $15.6 million for the nine months ended September 30, 2003 from $16.8 million during the same period in 2002. The decrease in net cash provided by operating activities
was primarily attributable to changes in amounts of unbilled receivables, inventories, accounts payable, other assets, accounts payable, accrued compensation and other accrued liabilities.



Net cash used in investing activities increased 88% to $2.9 million for the
nine months ended September 30, 2003 from $1.6 million during the same period in 2002. Net cash used in investing activities for both periods related to purchases of property and equipment. In the last quarter of 2003, we anticipate that cash used
in investing activities will increase slightly from cash used in investing activities in prior quarters.



Net cash used in financing activities was $33.0 million in the nine months ended September 30, 2003, compared to net cash provided by financing activities
of $1.6 million in the nine months ended September



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30, 2002. In the nine months ended September 30, 2003, we used approximately $35.4 million to repurchase 8,969,984 restricted shares of common stock in a
privately-negotiated transaction. Net cash provided by financing activities in both periods resulted from proceeds from the issuance of common stock upon the exercise of stock options and purchases under our employee stock purchase plan.



We may in the future pursue acquisitions of businesses, products or
technologies, or enter into joint venture arrangements, that could complement or expand our business and product offerings. Any material acquisition or joint venture could 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 to utilize any cash and cash equivalents that exceed our working capital requirements, including payment of cash dividends, additional stock
repurchases or other similar transactions.



At September 30,
2003, we had no long-term debt or material commitments for capital expenditures. We believe that our current cash balances and expected future cash flows will be sufficient to meet our anticipated cash needs for working capital, capital expenditures
and other activities for at least the next 12 months. Beyond that, if current sources are not sufficient to meet our needs, we may seek additional equity or debt financing. In addition, any material acquisition of other businesses, products or
technologies or material investments in joint ventures could require us to obtain additional equity or debt financing. There can be no assurance that additional financing would be available on acceptable terms, if at all.



Accounting Policies



In preparing our consolidated financial statements in conformity with U.S.
generally accepted accounting principles, or GAAP, we use certain estimates and assumptions that affect the reported amounts and related disclosures and may vary from actual results. We consider the following accounting policies as those most
important to the portrayal of our financial condition and those that require the most judgment or the greatest use of estimates. Although we believe that our estimates and assumptions are reasonable, actual results may differ, and such differences
could be significant to our financial results.



Revenue
Recognition



General.We derive revenues
primarily from product and license fees as well as services, which include training, warranty and product support services. The majority of the contracts for our GeoProbe, Orion and Beamer products contain multiple billing milestones, such as
contract award, shipment, installation and acceptance, not all of which are associated with revenue recognition. Except as otherwise discussed below, revenues from product and license fees are recognized in the period that we have completed all
hardware manufacturing and/or software development to contractual specifications, factory testing has been completed, the product has been shipped to the customer, the fee is fixed and determinable and collection of the fee is considered probable.
When we have significant obligations subsequent to shipment, such as installation and system integration, revenues are recognized when there are no significant unfulfilled obligations. Revenues from arrangements that include significant acceptance
terms and/or provisions are recognized when acceptance has occurred. Revenues from our Diagnostics products are typically recognized when title and risk of loss pass to the customer, which typically occurs at shipment. For these products, we
typically 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 of revenues in our
consolidated statements of income.



Multiple-element
arrangements.Contracts for our GeoProbe, Orion and Beamer products are typically multiple element arrangements, which means they involve multiple deliverables. We determine the fair value of each of the contract deliverables using
vendor-specific objective evidence, or VSOE. VSOE for



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each element is based on the price for which we would sell the element on a stand-alone basis. We offer our customers product support services, which include
the correction of software problems, telephone access to our technical personnel and the right to receive unspecified product updates, upgrades and enhancements, when and if they become available. Revenues from these services, including
post-contract support included in initial licensing fees, are recognized ratably over the service period. Post-contract support included in the initial licensing fee are allocated from the total contract amount based on the fair value of these
services determined using VSOE. Revenues from other services, such as training, are recognized when the services have been completed. If we determine that we do not have VSOE on an undelivered element of an arrangement, we will not recognize revenue
until all elements of the arrangement are delivered. This occurrence could materially impact our financial results because of the significant dollar amount of many of our contracts and the significant portion of total revenues that a single contract
may represent in any particular period.



Trade Accounts
Receivable and Allowance for Doubtful Accounts



A
large portion of our revenues and accounts receivable are attributable to our carrier customers in the communications industry and, to a lesser extent, to our equipment manufacturer customers who supply equipment into the communications industry.
Our trade accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our customers. Because our accounts receivable are usually unsecured, we periodically evaluate the collectibility of our accounts based
on a combination of factors, including a particular customers ability to pay and the 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
other information provided by the customer, or third-party credit analysis reports or other publicly-available information. In cases where the evidence suggests a customer may not be able to satisfy its obligations to us, we set up a specific
reserve in an amount we determine appropriate for the perceived risk. Most of our contracts include multiple payment milestones, some of which occur in advance of revenue recognition, which mitigates our risk both in terms of collectibility and
adjustments to recorded revenue. Given that most of our customers are large public companies with substantial resources, we have not historically experienced significant losses on uncollectible accounts and our allowance has been less than 5% of
recorded receivables. If the current downturn in the communications industry continues, the financial condition of our customers could deteriorate and they may not be able to meet their financial obligations to us. If this were to occur, the net
value realized from our receivables may be materially different from the net balance recorded on our balance sheet.



Inventory Reserves



Inventories are recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate the status of our
inventory on a quarterly basis to ensure that the amount recorded in our financial statements reflects the lower of our cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the
condition and salability of our inventory and the forecasted demand for the particular products incorporating these components. Based on current backlog and expected orders, we forecast the upcoming usage of current stock. We record reserves for
obsolete and slow-moving parts of up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk.
If market conditions deteriorate or the expected future demand for our products otherwise decreases, or if changes in our business strategy reduce our need for these components, our estimate of the carrying value of our inventory could be reduced by
a material amount.



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Income Taxes



In the preparation of our provision for income taxes and determination of whether deferred tax assets will be realized in
full or in part, we must estimate several factors. When it is more likely than not that all or some portion of the deferred tax asset will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that is
determined not to be realizable. As of September 30, 2003 and December 31, 2002, a valuation for deferred tax assets was not deemed necessary. If the facts or financial results on which our estimates are based were to change, thereby impacting the
likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of valuation allowance required in any given period. Additionally, our income tax returns are subject to review and examination in the various
jurisdictions in which we operate. We are currently not aware of any issues that have been raised by taxing jurisdictions, and management believes that all income tax issues which may be raised as a result of such reviews and examinations in the
future will be resolved with no material impact on our financial position or future results of operations. However, in the event there was an assessment by any of these jurisdictions, it could impact our tax provision.



Risk Factors



You should carefully consider the risks described below before making an
investment decision regarding our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties that we do not presently know or that we currently deem immaterial may also
impair our business operations. This document is qualified in its entirety by these risk factors.



If any of the following risks actually occur, they could materially harm our business, financial condition or results of operations. In that case, the
trading price of our common stock could decline.



Our
quarterly financial results fluctuate and are difficult to predict.



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



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



| |  | the timing of the delivery to and the installation and acceptance of our products by our customers;
| | - | ---------------------------------------------------------------------------------------------------



| |  | the timing of our development and introduction of new products or applications;
| | - | -------------------------------------------------------------------------------



| |  | the relative mix of product and license fees and services fees included in our revenues;
| | - | ----------------------------------------------------------------------------------------



| |  | the relative mix of hardware- and software-related revenues in our total revenues;
| | - | ----------------------------------------------------------------------------------



| |  | the relative percentages of products sold through our direct and indirect sales channels;
| | - | -----------------------------------------------------------------------------------------



| |  | the timing of and level of our investments in research and development activities, and the timing of and magnitude of our sales and marketing and general and administrative
expenses;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | changes in, and our ability to implement, our strategy; and
| | - | -----------------------------------------------------------



| |  | other risks described below.
| | - | ----------------------------



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



Our financial results
are also likely to fluctuate due to factors that impact our current and prospective customers. Expenditures by customers tend to vary in cycles that reflect overall economic conditions, individual budgeting and buying patterns and, in some cases,
the ability of some of our customers to obtain the financing they require to make capital expenditures. Our business has been harmed by a softening economy, and we would be further harmed by a continued decline in the economic prospects of our
customers or the economy in general. This harm would be exacerbated by a decline in the economic prospects of our current and prospective customers in Europe, as revenues from this region have historically represented the majority of our total
revenues. In many cases, these adverse economic conditions have altered current and prospective customers capital spending priorities or budget cycles, which have extended our sales cycle. These adverse effects could continue and could impact
our customers ability to meet their financial obligations to us. Our business also could be harmed by changes in customer spending patterns reflecting industry trends. For example, customer budgetary constraints have contributed to downward
sales price pressure on some of our products and on renewals of product support agreements for our GeoProbe and Orion products, which has adversely affected our revenues. In addition, our financial results historically have been influenced by
seasonal fluctuations, with orders and revenues tending to be strongest in the fourth quarter of each year and orders and revenues in our first quarter tending to be lower than the levels achieved in the preceding quarter. We believe that this
seasonality has been due in large part to the capital appropriation practices of many of our customers.



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



A further slowdown in communications spending, or consolidations or
bankruptcies in the communications industry could harm our business, financial condition and results of operations.



We have derived substantially all of our revenues from sales of products and related services to the communications industry. Since early 2001, we and a
number of other companies have been impacted by reduced spending by communications carriers and equipment manufacturers, and some industry analysts project further spending reductions in future periods. In some cases, the continued viability of some
carriers and equipment manufacturers is in question. Our business, financial condition and results of operations could be materially harmed in the event that conditions continue to worsen in our industry or in the event that there are consolidations
of our current customers, which could result in the displacement of our products by a competitors products preferred by the other party to the consolidation, or bankruptcies of our current or prospective customers, which could result in
reduced revenues or significant write-offs of uncollectible accounts receivable. Additionally, slowdowns in spending often cause delays in sales and installations and could cause cancellations of current or planned projects, any of which could harm
our financial results in a particular period.



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



A key component of our strategy is the ability to successfully develop,
introduce and market new Unified Assurance and Diagnostics products and applications. Although we have obtained feedback from our customers and potential customers regarding our development and product strategy, we have made certain assumptions as
to the needs of our customers and the features, functionality and performance expected by them. Our current or prospective customers may not order these new products and applications.



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Also, purchase decisions regarding our new Orion and Beamer products and applications may be made by
individuals within organizations with which we have no significant existing relationships, such as customer service or sales and marketing departments. We may not be successful in developing the relationships necessary to sell our Orion and Beamer
products and applications.



Our revenues are highly
concentrated among a small number of customers.



A
large percentage of our revenues are typically derived from a small number of customers, and we expect this trend to continue. For example, in the nine months ended September 30, 2003, approximately 72% of our revenues were derived from the ten
largest customers in the period, with one international customer accounting for approximately 22%. Additionally, British Telecom and Deutsche Telekom, on a combined basis, accounted for approximately 31% of total revenues in the nine months ended
September 30, 2003. Although the customer make-up of our largest projects varies from quarter to quarter, a small number of significant repeat customers frequently account for a significant portion of our revenues in a given period. If we lose one
of our significant repeat customers, our financial results could be harmed. Additionally, if one or more of these significant repeat customers experiences adverse conditions in its industry or operations, including the continued impact of the
current economic downturn and reductions in communications spending, these customers may not be able to meet their ongoing financial obligations to us or purchase additional products.



Changes or delays in the implementation or customer acceptance of our products could harm our financial results.



Revenues for our Unified Assurance Solution products,
which accounted for the majority of our total revenues in the nine months ended September 30, 2003, are typically recognized upon the completion of system installation or customer acceptance. Delays caused by us or our customers in the commencement
or completion of scheduled product installations and acceptance testing may occur from time to time due to site-readiness delays, the often comprehensive processes for testing and acceptance required by certain of our customers, insufficient
personnel on the part of us or our customers to complete a project, the lengthening of implementation schedules due to the introduction of new features or applications, or other issues. Because a significant portion of our revenues on a quarterly
basis is derived from a small number of customer projects, product installation delays could materially harm our financial results for a particular period. With respect to contracts providing for a significant payment or performance milestone tied
to customer acceptance or allowing customer return, termination or similar rights prior to acceptance, we generally do not recognize revenue until acceptance is achieved. For new products, we typically recognize revenue initially upon acceptance. As
a result, in cases where the recognition of revenue is tied to customer acceptance, the failure to obtain acceptance or delayed acceptance could harm our financial results for a particular period. Additionally, we may be subject to penalties or
other customer claims for a failure to meet contractually agreed upon milestones or deadlines.



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



Sales of our Unified Assurance Solution products, which since 1998 have accounted for the majority of our total revenues, are made predominantly to large
communications carriers and involve significant capital expenditures as well as lengthy sales cycles and implementation processes. Sales to this type of customer generally require an extensive sales effort throughout the customers organization
and final approval by an executive officer or other senior-level approval. We expend substantial funds and management effort pursuing these sales. Additionally, potential customers often maintain comprehensive processes for internal approval,
contracting and procurement, which may cause potential sales to be



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delayed or foregone. As a result of these and other factors, the sales cycle for our products is long, historically ranging from six to 18 months for our
Unified Assurance Solution (excluding the cycle for subsequent applications and enhancements, which varies widely) and averaging three months for occasional, large sales of our Diagnostics products. Accordingly, our ability to forecast the timing
and amount of specific sales is limited, and the deferral or loss of one or more significant sales could materially harm our financial results in a particular quarter, especially if there are significant sales and marketing expenses associated with
any deferred or lost sales.



Competition is intense, may
intensify and could result in increased downward pricing pressure, further reduced margins and the loss of market share.



Competition for all of our products is intense, is expected to continue and in some cases may intensify. We compete principally with a number of U.S. and
international suppliers that vary in size and in the scope and breadth of the products and services offered. We compete to a lesser extent 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 other resources. As a result, these competitors may be able to more quickly develop or adapt to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, promotion and sale of
their products. Additionally, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. Increased competition could result in increased downward pricing pressure, further reduced
margins and the loss of market share. We continue to experience pressure on sales prices for our GeoProbe and Orion products, especially for those applications for which there is a competitive offering, or in highly competitive situations involving
prospective customers.



Our business depends on retaining
our existing key personnel.



Our business depends to a
significant extent upon the continued service and performance of a relatively small number of key senior managers, technical personnel and sales and marketing personnel, none of whom are bound by an agreement to remain in our employ. The loss of any
existing key personnel, or the inability to attract, motivate and retain additional key personnel, could harm our business, financial condition and results of operations.



We may be unable to adapt to rapid technological change and evolving customer requirements.



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



| |  | develop and introduce new products or applications for the communications market;
| | - | ---------------------------------------------------------------------------------



| |  | enhance our Unified Assurance Solution and Diagnostics products;
| | - | ----------------------------------------------------------------



| |  | keep pace with evolving industry protocol standards, next-generation technologies and changing customer needs; and
| | - | ------------------------------------------------------------------------------------------------------------------



| |  | achieve broad market acceptance for our products.
| | - | -------------------------------------------------



We cannot assure you that we will achieve these objectives.



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Over the long term, we expect carrier spending for traditional networks to decrease from current levels,
which requires that we continue to develop products and applications for networks based on emerging next-generation wireless and packet-based technologies and standards. We may not successfully develop additional competitive products for these
emerging technologies and standards.



Products as complex as
those currently under development by us frequently are subject to delays, and we cannot assure you that we will not encounter difficulties, such as the inability to assign a sufficient number of qualified technical personnel to key projects or other
unanticipated causes, that could delay or prevent the successful and timely development, introduction and marketing of these potential new products. Even if such potential new products are developed and introduced, we cannot assure you that they
will achieve any significant degree of market acceptance. In addition, our products are implemented with our purpose-specific hardware platform and certain third-party hardware. We cannot assure you that we will be able to design and manufacture, or
procure from third parties, the hardware necessary to successfully implement our new products and applications.



A majority of our revenues have historically come from our international customers, and, as a result, our business may be harmed by political and
economic conditions in foreign markets and the challenges associated with operating internationally.



Historically, revenues from international markets have represented the majority of our total revenues, and international revenues as a percentage of total
revenues have increased in recent quarters. We expect revenues from international markets to continue to represent the majority of our total revenues for the foreseeable future. International business activities involve certain risks, including:



| |  | management of our geographically dispersed operations;
| | - | ------------------------------------------------------



| |  | longer sales cycles in certain countries, especially on initial entry into a new geographical market;
| | - | -----------------------------------------------------------------------------------------------------



| |  | greater difficulty in evaluating a customers ability to pay, longer accounts receivable payment cycles and greater difficulty in the collection of past-due accounts;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | general economic conditions in each country;
| | - | --------------------------------------------



| |  | currency controls and exchange rate fluctuations;
| | - | -------------------------------------------------



| |  | challenges associated with operating in diverse cultural and legal environments;
| | - | --------------------------------------------------------------------------------



| |  | seasonal reductions in business activity specific to certain markets;
| | - | ---------------------------------------------------------------------



| |  | loss of revenues, property and equipment from expropriation, nationalization, war, insurrection, terrorism and other political risks;
| | - | -------------------------------------------------------------------------------------------------------------------------------------



| |  | foreign taxes and the overlap of different tax structures, including modifications to the U.S. tax code as a result of international trade regulations;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | greater difficulty in safeguarding intellectual property;
| | - | ---------------------------------------------------------



| |  | import and export licensing requirements and other trade restrictions;
| | - | ----------------------------------------------------------------------



| |  | involuntary renegotiation of contracts with foreign governments and communications carriers; and
| | - | ------------------------------------------------------------------------------------------------



| |  | existence or adoption of laws and regulations affecting the operation and taxation of our business and the general business climate for foreign companies.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------



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



We could experience
delays or reductions in product shipments or increases in product costs if we are unable to obtain sufficient key components as required or to develop alternative sources if and as required in the future. Currently, our products utilize certain
components that are available from only one or a limited number of suppliers. While alternative suppliers have been identified for a variety of key components, those alternative sources have not been qualified or activated by us. Our qualification
process could be lengthy, and we cannot assure you that additional sources would become available to us on a timely basis, or if such sources were to become available, that the components would be comparable in price and quality to our current
components. We generally do not execute long-term supply agreements with our suppliers and, in the case of many components, make our purchases with purchase orders on an as-needed basis. Some of the components our products utilize
require long order lead-times, in certain cases up to nine months. Other components that currently are readily available may become difficult to obtain in the future. Our failure to order sufficient quantities of these components in advance of
product delivery deadlines could prevent us from adequately responding to unanticipated increases in customer orders. In the past, we have experienced delays in the receipt of a variety of our key components, which have resulted in delays in product
deliveries. In addition, the cost of various key components of our products has fluctuated significantly in the past based on supply and demand factors. Significant changes in supply and demand characteristics in the future could cause the cost of
various components to increase, which could adversely impact our product costs.



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



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



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Our inventory may become obsolete or unusable.



From time to time, we make advance purchases of various component parts in
relatively large quantities to ensure that we have an adequate and readily available supply. Our failure to accurately project our needs for these components and the demand for our products that incorporate them, or changes in our business strategy
that reduce our need for these components, could result in these components becoming obsolete 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 the manufacture and
development of our products. Our ability to sell products to our customers could be impaired if these subcontractors do not meet their commitments to us.



Any disruption in our relationships with third-party subcontractors and our inability to develop alternative sources if and
as required in the future could result in delays or reductions in product shipments or increases in product costs. We rely exclusively upon third-party subcontractors to manufacture our subassemblies, and we have retained, from time to time,
third-party design services in the layout of circuit boards. We also frequently subcontract the development of specific features or enhancements for our products. Our reliance on third-party subcontractors involves a number of risks, including the
potential absence of adequate capacity, the unavailability of or interruption in access to various process technologies, and reduced control over product quality, delivery schedules, manufacturing yields and costs.



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



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



We may not receive the intended benefits of future acquisitions, joint ventures or other business relationships.



We may in the future pursue acquisitions of businesses, products and
technologies, or the establishment of joint venture, strategic partnership or other arrangements that could expand our business and product offerings. The negotiation of potential acquisitions or strategic relationships, as well as the integration
of an acquired or jointly developed business, technology or product, could cause diversion of managements time and resources. Future acquisitions and strategic relationships by us could result in potentially dilutive issuances of equity
securities, a material reduction in cash reserves, the incurrence of debt and contingent liabilities, research and development write-offs and other acquisition-related expenses. We cannot assure you that any acquisition or joint venture will be
successfully integrated with our operations. If we were to pursue any such acquisition or strategic relationship, we may not receive the intended benefits of the acquisition or strategic relationship.



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



The communications
industry is characterized by the existence of a large number of patents and frequent allegations of patent infringement. We have received, and may receive in the future, notices from holders of patents that raise issues as to possible infringement
by our products. As the number of competitive products increases and the functionality of these products further overlaps, we believe that we may become increasingly subject to allegations of infringement. Questions of infringement and the validity
of patents in the field of communications signaling technologies involve highly technical and subjective analyses. Patent holders may initiate legal proceedings in the future against us, and if any proceedings are initiated, we may not be successful
in defending ourselves. Any claim or proceeding could be time consuming and expensive to defend or resolve, result in substantial diversion of management resources, cause product shipment delays, or force us to enter into royalty or license
agreements rather than dispute the merits of any such claim made or proceeding initiated against us. Any such royalty or license agreements may not be available on terms acceptable to us, if at all.



Our limited ability or failure to protect our intellectual property may
materially harm our ability to compete.



Our continued
success is dependent in part upon our proprietary technology. To protect our proprietary technology, we rely on a combination of technical innovation, trade secret, copyright and trademark laws, non-disclosure agreements and, to a lesser extent,
patents, each of which affords only limited protection. In addition, the laws of some foreign countries do not protect our proprietary rights in our products to the same extent as do the laws of the U.S. Despite the measures taken by us, it may be
possible for a third party to copy or otherwise obtain and use our proprietary technology and information without authorization. Policing unauthorized use of our products is difficult, and litigation may be necessary in the future to enforce our
intellectual property rights. Any litigation could be time consuming and expensive to prosecute or resolve, result in substantial diversion of management attention and resources, and materially harm our business, financial condition and results of
operations. We may not be successful in protecting our proprietary technology or our proprietary rights may not provide us a meaningful competitive advantage.



We may face potential liability for product defects.



Products as complex as ours may contain undetected defects or errors, especially when first introduced or as enhancements
are released, that, despite our testing, are not discovered until after a product has been installed and used by customers. Defects or errors could result in delayed market acceptance of the product, claims against us or damage to our reputation and
business. We generally include provisions in our agreements with customers that are intended to limit our exposure to potential liability for damages arising out of defects or errors in our products. However, the nature and extent of these
limitations vary from agreement to agreement, and it is possible that these limitations may not be effective as a result of unfavorable judicial decisions or current or future laws 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 sale and support of our products entail the risk of these claims. We carry insurance that mitigates our risk associated with certain product liability claims, but the policy
is subject to coverage limits, various exceptions and options to cancel prior to term and may not be sufficient to cover all claims. Any product liability claim brought against us, regardless of its merit, could result in material expense to us,
diversion of management attention and resources, and damage to our business reputation and our ability to retain existing customers or attract new customers.



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Our business and reputation could suffer if we do not prevent security breaches.



We have included security features in some of our
products that are intended to protect the privacy and integrity of customer data. Despite the existence of these security features, our products may be vulnerable to breaches in security due to unknown defects in the security mechanisms, as well as
vulnerabilities inherent in the operating system or hardware platform on which the product runs and/or the networks linked to that platform. Security vulnerabilities, regardless of origin, could jeopardize the security of information stored in and
transmitted through the computer systems of our customers. Any security problem may require significant capital expenditures to solve and could materially harm our reputation and product acceptance.



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



As of October 17, 2003, two of our founders, Samuel S. Simonian, chairman of our board, and Elie S. Akilian, our president and chief executive officer and
a director, collectively beneficially owned approximately 40% of the outstanding shares of our common stock. Consequently, if these individuals were to act together, they could effectively control the outcome of all matters submitted for stockholder
action, including the election of our board of directors and the approval of significant corporate transactions. They also effectively control the management and affairs of our company, which could have the effect of delaying or preventing a change
in control of our company. In addition, as two of the five members of our board of directors, Messrs. Simonian and Akilian have significant influence in directing the actions taken by our board.



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



Our
certificate of incorporation and bylaws and Delaware law contain provisions that may have the effect of discouraging, delaying or preventing a change in control of our company or unsolicited acquisition proposals that a stockholder may consider
favorable. For example, we have a classified board of directors with staggered, three-year terms, our stockholders are unable to take action by written consent, our stockholders are limited in their ability to make proposals at stockholder meetings,
and our board of directors is empowered to issue blank-check preferred stock without any need to obtain stockholder approval.



Volatility in our stock price could result in claims against us.



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



|2003           |  | High |       | Low
|-------------- |  | ---- | ----- | ---
|Third Quarter  |  | $    | 16.00 |    
|Second Quarter |  |      | 10.50 |    
|First Quarter  |  |      | 8.25  |    
|               |  |     
|2002           |  |      |       |    
|Fourth Quarter |  | $    | 6.98  |    
|Third Quarter  |  |      | 6.68  |    
|Second Quarter |  |      | 10.30 |    
|First Quarter  |  |      | 11.05 |    



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Our stock price may be significantly affected by factors such as:



| |  | variations in our results of operations;
| | - | ----------------------------------------



| |  | changes in our business strategy;
| | - | ---------------------------------



| |  | future sales of our common stock, particularly by institutional investors with large holdings and by our founders;
| | - | ------------------------------------------------------------------------------------------------------------------



| |  | the announcement of technological innovations or new products by us, our competitors or others;
| | - | -----------------------------------------------------------------------------------------------



| |  | market analysts estimates of our performance, our customers or competitors performance or the performance of the communications industry in general;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the financial and other announcements made by us, our competitors or customers;
| | - | -------------------------------------------------------------------------------



| |  | general market and economic conditions; and
| | - | -------------------------------------------



| |  | equity market conditions and industry-specific equity market trends.
| | - | --------------------------------------------------------------------



The public markets have experienced significant volatility that has particularly affected the market prices of securities of many technology and
communications companies for reasons that have often been unrelated to financial results. This volatility has and may continue to materially harm the market price of our common stock as well as our visibility and credibility in our markets.



Additionally, in the past, securities class action litigation
often has been brought against a company following periods of volatility in the market price of its common stock. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and diversion of
management attention and resources.



Item 3. Quantitative and Qualitative Disclosures about Market Risk



Historically, we have been exposed to immaterial levels of market risk and have not been significantly exposed to fluctuations in currency exchange rates.
Prior to 2002, less than 1% of total revenues had been denominated in currencies other than the U.S. dollar. In 2002, approximately 3% of total revenues was denominated in currencies other than the U.S. dollar, principally the Euro. In the nine
months ended September 30, 2003, approximately 1% of total revenues was denominated in currencies other than the U.S. dollar. In future periods, we believe a greater portion of total revenues could be denominated in currencies other than the U.S.
dollar, thereby increasing our exposure to exchange rate gains and losses on non-U.S. currency transactions. Currently, we do not engage in hedging activities for our non-US dollar business.



Our international subsidiaries operate in currencies other than the U.S.
dollar, which results in translation gains and losses; however, the U.S. dollar is the functional currency of all our subsidiaries. Currently, we do not engage in hedging activities for our international operations.



Our international business is subject to the typical risks of any
international business, including, but not limited to, the risks described in Item 2Managements Discussion and Analysis of Financial Condition and Results of OperationsRisk Factors. Accordingly, our future results could
be materially harmed by the actual occurrence of any of these or other risks.



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Currently, our cash is invested in bank deposits and money market funds denominated in U.S. dollars. We
account for these investments in accordance with SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. These cash equivalents are treated as available-for-sale under SFAS 115. The carrying value of these cash equivalents
approximates fair market value. Our investments are subject to interest rate risk, which is the risk that our financial condition and results of operations could be adversely affected due to movements in interest rates. Assuming current levels of
cash, if the per annum rate of interest earned on our invested cash were to change by 50 basis points, or 0.5%, our investment income would be impacted by approximately $0.8 million on an annual basis.



Item 4. Controls and Procedures



| | (a) | Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be
disclosed in the periodic reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the rules of the SEC. We carried out an evaluation as of September 30, 2003, under the supervision and the
participation of our management, including our chief executive officer and chief financial officer, of the design and operation of these disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our chief
executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the company (including our consolidated subsidiaries) required to be
included in our periodic SEC filings.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Changes in internal controls over financial reporting. There was no change in internal control over financial reporting that occurred during the three months ended September
30, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



PART II. OTHER INFORMATION



Item 2. Changes in Securities and Use of Proceeds



The Securities and Exchange Commission on May 26, 1999 declared effective our registration statement on Form S-1 (File No. 333-59753) relating to the initial public offering of our common stock. As of September 30,
2003, we have used all of the net offering proceeds for the purchase of temporary investments, consisting of cash, cash equivalents, and short-term investments. We currently intend to use the net proceeds of the offering for working capital and
general corporate purposes, including financing accounts receivable and capital expenditures made in the ordinary course of business. We also may apply a portion of the proceeds of the offering to acquire businesses, products and technologies, or
enter into joint venture arrangements, that are complementary to our business and product offerings; however, at this time we have not identified a specific acquisition or joint venture or allocated a specific amount for this purpose. We also may
apply a portion of the proceeds to the payment of cash dividends or for additional stock repurchases or other similar transactions.



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Item 6. Exhibits and Reports on Form 8-K



| | (a) | Exhibits
| | --- | --------



|     | 
|---- | 
|10.1 | 
|     | 
|31.1 | 
|     | 
|31.2 | 
|     | 
|32.1 | 
|     | 
|32.2 | 



| | (b) | Reports on Form 8-K
| | --- | -------------------



During the three months ended September 30, 2003 we filed a Current Report on Form 8-K on September 18, 2003. The report included information reported
under Item 5Other events and Item 7Financial Statements, Pro Forma Financial Information and Exhibits.



SIGNATURES



Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



INET TECHNOLOGIES, INC.By:

/s/    Jeffrey A. KuppJeffrey A. KuppVice President and Chief Financial Officer(Principal accounting and financial officer)




Date: October 21, 2003



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INET TECHNOLOGIES, INC.

INDEX TO EXHIBITS



|Exhibit Number |  | Description                                                                                                                                                                                                       
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|               | 
|10.1           |  | Amended and Restated Registration Rights Agreement dated September 30, 2003 by and among the registrant, Samuel S. Simonian and Elie S. Akilian                                                                   
|               | 
|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.                                                     
|               | 
|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.                                                
|               | 
|32.1           |  | Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.     
|               | 
|32.2           |  | Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.



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