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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q



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



For the quarterly period ended June 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. employeridentification 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)



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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  þ    No ̈



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



Number of shares of common stock outstanding at August 1, 2003: 38,644,566



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##### Table of Contents

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 |  | 13      
|                             |  |                                                                                      
|Item 3.                      |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 31      
|                             |  |                                                                                      
|Item 4.                      |  | Controls and Procedures                                                               |  | 31      
|                             | 
|Part IIOther Information    |  |                                                                                      
|                             |  |                                                                                      
|Item 2.                      |  | Changes in Securities and Use of Proceeds                                             |  | 32      
|                             |  |                                                                                      
|Item 4.                      |  | Submission of Matters to a Vote of Security Holders                                   |  | 32      
|                             |  |                                                                                      
|Item 6.                      |  | Exhibits and Reports on Form 8-K                                                      |  | 33      
|                             | 
|Signatures                   |  | 33                                                                                   



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PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



INET TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share data)



|                                                                                                                         |  | June 30,2003 |         |   | December 31,2002 |  
|------------------------------------------------------------------------------------------------------------------------ |  | ------------ | ------- | - | ---------------- | -
|ASSETS                                                                                                                   |  |              |         |   |                  |  
|                                                                                                                         |  |             
|Current assets:                                                                                                          |  |              |         |   |                  |  
|Cash and cash equivalents                                                                                                |  | $            | 162,312 |   |                  | $
|Trade accounts receivable, net of allowance for doubtful accounts of $507 at June 30, 2003 and $484 at December 31,
2002 |  |              | 13,660  |   |                  |  
|Unbilled receivables                                                                                                     |  |              | 352     |   |                  |  
|Inventories                                                                                                              |  |              | 6,769   |   |                  |  
|Deferred income taxes                                                                                                    |  |              | 850     |   |                  |  
|Other current assets                                                                                                     |  |              | 5,846   |   |                  |  
|                                                                                                                         |  |              |         |   |                  |  
|Total current assets                                                                                                     |  |              | 189,789 |   |                  |  
|Property and equipment, net                                                                                              |  |              | 13,392  |   |                  |  
|Other assets                                                                                                             |  |              | 583     |   |                  |  
|                                                                                                                         |  |              |         |   |                  |  
|Total assets                                                                                                             |  | $            | 203,764 |   |                  | $
|                                                                                                                         |  |              |         |   |                  |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                     |  |              |         |   |                  |  
|                                                                                                                         |  |             
|Current liabilities:                                                                                                     |  |              |         |   |                  |  
|Accounts payable                                                                                                         |  | $            | 2,716   |   |                  | $
|Accrued compensation and benefits                                                                                        |  |              | 2,961   |   |                  |  
|Deferred revenues                                                                                                        |  |              | 23,056  |   |                  |  
|Income taxes payable                                                                                                     |  |              | 2,486   |   |                  |  
|Other accrued liabilities                                                                                                |  |              | 3,129   |   |                  |  
|                                                                                                                         |  |              |         |   |                  |  
|Total current liabilities                                                                                                |  |              | 34,348  |   |                  |  
|Deferred income taxes                                                                                                    |  |              | 18      |   |                  |  
|Commitments and contingencies                                                                                            |  |              |         |   |                  |  
|Stockholders equity:                                                                                                    |  |              |         |   |                  |  
|Preferred stock, $.001 par value:                                                                                        |  |              |         |   |                  |  
|Authorized shares25,000,000                                                                                             |  |              |         |   |                  |  
|Issued sharesNone                                                                                                       |  |              |        |   |                  |  
|Common stock, $.001 par value:                                                                                           |  |              |         |   |                  |  
|Authorized shares175,000,000 Issued shares47,159,643 at June 30, 2003 and 47,157,543 at December 31, 2002              |  |              | 47      |   |                  |  
|Additional paid-in capital                                                                                               |  |              | 75,413  |   |                  |  
|Unearned compensation                                                                                                    |  |              | (345    | ) |                  |  
|Retained earnings                                                                                                        |  |              | 128,767 |   |                  |  
|Treasury stock, 8,723,435 common shares at June 30, 2003 and no common shares at December 31, 2002, at cost              |  |              | (34,484 | ) |                  |  
|                                                                                                                         |  |              |         |   |                  |  
|Total stockholders equity                                                                                               |  |              | 169,398 |   |                  |  
|                                                                                                                         |  |              |         |   |                  |  
|Total liabilities and stockholders equity                                                                               |  | $            | 203,764 |   |                  | $
|                                                                                                                         |  |              |         |   |                  |  



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 endedJune 30, |        | Six months endedJune 30,
|---------------------------------------- |  | -------------------------- | ------ | ------------------------
|                                         |  | 2003                       |        |                         
|Revenues:                                |  |                            |        |                         
|Product and license fees                 |  | $                          | 17,770 |                         
|Services                                 |  |                            | 7,702  |                         
|                                         |  |                            |        |                         
|Total revenues                           |  |                            | 25,472 |                         
|                                         |  |                            |        |                         
|Cost of revenues:                        |  |                            |        |                         
|Product and license fees                 |  |                            | 6,336  |                         
|Services                                 |  |                            | 3,303  |                         
|                                         |  |                            |        |                         
|Total cost of revenues                   |  |                            | 9,639  |                         
|                                         |  |                            |        |                         
|Gross profit                             |  |                            | 15,833 |                         
|Operating expenses:                      |  |                            |        |                         
|Research and development                 |  |                            | 7,257  |                         
|Sales and marketing                      |  |                            | 3,608  |                         
|General and administrative               |  |                            | 2,061  |                         
|                                         |  |                            |        |                         
|                                         |  |                            | 12,926 |                         
|                                         |  |                            |        |                         
|Income from operations                   |  |                            | 2,907  |                         
|Other income (expense):                  |  |                            |        |                         
|Interest income                          |  |                            | 372    |                         
|Other income (expense)                   |  |                            | (125   | )                       
|                                         |  |                            |        |                         
|                                         |  |                            | 247    |                         
|                                         |  |                            |        |                         
|Income before provision for income taxes |  |                            | 3,154  |                         
|Provision for income taxes               |  |                            | 883    |                         
|                                         |  |                            |        |                         
|Net income                               |  | $                          | 2,271  |                         
|                                         |  |                            |        |                         
|Earnings per common share:               |  |                            |        |                         
|Basic                                    |  | $                          | 0.06   |                         
|                                         |  |                            |        |                         
|Diluted                                  |  | $                          | 0.06   |                         
|                                         |  |                            |        |                         
|Weighted-average shares outstanding:     |  |                            |        |                         
|Basic                                    |  |                            | 38,400 |                         
|                                         |  |                            |        |                         
|Diluted                                  |  |                            | 38,689 |                         
|                                         |  |                            |        |                         



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 $181 |  | 2,100        |  |                          |   |                      |   | 338    |                  |   | (109           | )      |  |                          |       
|Net income                                                                                                   |  |             |  |                          |   |                      |   |       |                  |   |               |        |  |                          | 5,526  
|Amortization of restricted stock awards                                                                      |  |             |  |                          |   |                      |   |       |                  |   | 171            |        |  |                          |       
|                                                                                                             |  |              |  |                          |    |                      |   |        |                  |   |                |        |  |                          |        
|Balance at June 30, 2003                                                                                     |  | 47,159,643   |  | $                        | 47 |                      | $ | 75,413 |                  | $ | (345           | )      |  | $                        | 128,767
|                                                                                                             |  |              |  |                          |    |                      |   |        |                  |   |                |        |  |                          |        



See accompanying notes
to consolidated financial statements.



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INET TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



|                                                                                                                       |  | Six months ended June 30, |        
|---------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | -------
|                                                                                                                       |  | 2003                      |        
|Cash flows from operating activities:                                                                                  |  |                           |        
|Net income                                                                                                             |  | $                         | 5,526  
|Adjustments to reconcile net income to net cash provided by operating activities:                                      |  |                           |        
|Depreciation                                                                                                           |  |                           | 3,577  
|Stock compensation                                                                                                     |  |                           | 171    
|Changes in operating assets and liabilities:                                                                           |  |                           |        
|(Increase) decrease in trade accounts receivable                                                                       |  |                           | (3,449 
|(Increase) decrease in unbilled receivables                                                                            |  |                           | (197   
|Decrease in income taxes receivable                                                                                    |  |                           |       
|Decrease in inventories                                                                                                |  |                           | 689    
|(Increase) decrease in other assets                                                                                    |  |                           | (1,220 
|Increase (decrease) in accounts payable                                                                                |  |                           | 1,638  
|Increase in taxes payable                                                                                              |  |                           | 714    
|Increase (decrease) in accrued compensation and benefits                                                               |  |                           | (1,152 
|Increase in deferred revenues                                                                                          |  |                           | 4,733  
|Increase (decrease) in other accrued liabilities                                                                       |  |                           | (1,104 
|                                                                                                                       |  |                           |        
|Net cash provided by operating activities                                                                              |  |                           | 9,926  
|                                                                                                                       |  |                          
|Cash flows from investing activities:                                                                                  |  |                           |        
|Purchases of property and equipment                                                                                    |  |                           | (2,254 
|                                                                                                                       |  |                           |        
|Net cash used in investing activities                                                                                  |  |                           | (2,254 
|                                                                                                                       |  |                          
|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 |  |                           | 1,117  
|                                                                                                                       |  |                           |        
|Net cash provided by (used in) financing activities                                                                    |  |                           | (34,436
|                                                                                                                       |  |                           |        
|Net (decrease) increase in cash and cash equivalents                                                                   |  |                           | (26,764
|Cash and cash equivalents at beginning of period                                                                       |  |                           | 189,076
|                                                                                                                       |  |                           |        
|Cash and cash equivalents at end of period                                                                             |  | $                         | 162,312
|                                                                                                                       |  |                           |        
|Supplemental disclosure:                                                                                               |  |                           |        
|Income taxes paid                                                                                                      |  | $                         | 1,582  
|                                                                                                                       |  |                           |        



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



Founded in 1989, Inet Technologies, Inc. is a leading global provider of
communications software solutions that enable communications carriers to more strategically operate their businesses. We have two solution areasour Unified Assurance solutions and our Diagnostics solutions. Our Unified Assurance solutions
include the GeoProbe, Orion and Beamer products, which capture signaling network traffic and then process, correlate and analyze the raw data to create a network-wide view for troubleshooting, problem detection and network integrity assurance. These
products alert carriers to network problems, such as congestion, misrouted calls due to equipment errors, service degradation and fraud, so that action can be taken to proactively resolve issues, often before the end customer is impacted and
significant revenue is lost. Our Diagnostics solutions include the Spectra2, Spectra and Spectra Trunk Tester products, which allow communications carriers and equipment manufacturers to quickly and cost-effectively design, deploy and maintain
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 Annual Report on Form 10-K filed with the Securities and Exchange Commission, or
SEC, on February 28, 2003. Operating results for the three- and six-month periods ended June 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.



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.



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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 receivables 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.



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 June 30,
2003 and December 31, 2002, inventories consisted of the following (in thousands):



|                |  | June 30,2003 |       | December 31,2002
|--------------- |  | ------------ | ----- | ----------------
|Raw materials   |  | $            | 2,765 |                 
|Work-in-process |  |              | 412   |                 
|Finished goods  |  |              | 3,592 |                 
|                |  |              |       |                 
|                |  | $            | 6,769 |                 
|                |  |              |       |                 



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.



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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 Unified Assurance solutions 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, in our judgment, 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
solutions 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 Unified Assurance solutions 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 product warranty services included in initial licensing fees, are recognized ratably over the contract period. Product warranty services included in the initial licensing fee are allocated from the total
contract amount based on the relative 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.



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 are determined not to be
realizable. As of June 30, 2003 and June 30, 2002, a valuation for deferred tax assets was not deemed necessary. Accordingly, if the facts or financial results 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



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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 June 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 June 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 June 30, 2003, unearned stock compensation related to our stock issuance program was approximately $0.3 million. We had no unearned stock compensation at June 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 six months ended June 30, 2003 and the three and six months ended June 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):



|                                                                                                        |  | Three months endedJune 30, |       |      | Six months ended June 30, |       
|------------------------------------------------------------------------------------------------------- |  | -------------------------- | ----- | ---- | ------------------------- | ------
|                                                                                                        |  | 2003                       |       | 2002 |                           |       
|Net income, as reported                                                                                 |  | $                          | 2,271 |      | $                         | 1,325 
|Stock compensation expense recorded under the intrinsic value method, net of income taxes               |  |                            | 21    |      |                           |      
|Pro forma stock compensation income (expense) computed under the fair value method, net of income taxes |  |                            | 1,468 |      |                           | (3,820
|                                                                                                        |  |                            |       |      |                           |       
|Pro forma net income (loss)                                                                             |  | $                          | 3,760 |      | $                         | (2,495
|                                                                                                        |  |                            |       |      |                           |       
|Basic earnings per common share, as reported                                                            |  | $                          | 0.06  |      | $                         | 0.03  
|                                                                                                        |  |                            |       |      |                           |       
|Diluted earnings per common share, as reported                                                          |  | $                          | 0.06  |      | $                         | 0.03  
|                                                                                                        |  |                            |       |      |                           |       
|Pro forma basic earnings (loss) per common share                                                        |  | $                          | 0.10  |      | $                         | (0.05 
|                                                                                                        |  |                            |       |      |                           |       
|Pro forma diluted earnings (loss) per common share                                                      |  | $                          | 0.10  |      | $                         | (0.05 
|                                                                                                        |  |                            |       |      |                           |       



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



|                                               |  | Three months endedJune 30, |      |   | Six months endedJune 30, |  
|---------------------------------------------- |  | -------------------------- | ---- | - | ------------------------ | -
|                                               |  | 2003                       |      |   | 2002                     |  
|Volatility                                     |  |                            | 0.95 |   |                          |  
|Weighted-average expected lives                |  |                            | 3.01 |   |                          |  
|Expected dividend yields                       |  |                            |     |   |                          |  
|Weighted-average risk-free interest rates      |  |                            | 1.55 | % |                          |  
|Weighted-average fair value of options granted |  | $                          | 5.27 |   |                          | $



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



|                                                              |  | Three months endedJune 30, |      |   | Six months endedJune 30, |  
|------------------------------------------------------------- |  | -------------------------- | ---- | - | ------------------------ | -
|                                                              |  | 2003                       |      |   | 2002                     |  
|Volatility                                                    |  |                            | 0.97 |   |                          |  
|Weighted-average expected lives                               |  |                            | 0.50 |   |                          |  
|Expected dividend yields                                      |  |                            |     |   |                          |  
|Weighted-average risk-free interest rates                     |  |                            | 1.15 | % |                          |  
|Weighted-average fair value of employee stock purchase rights |  | $                          | 3.35 |   |                          | $



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 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 June 30, 2003 and approximately $0.3 million for these services in the three months ended June 30,
2002. We expensed approximately $0.2 million for these services in the six months ended June 30, 2003 and approximately $0.6 million for these services in the six months ended June 30, 2002.



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Note 3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 endedJune 30, |        | Six months endedJune 30,
|--------------------------------------------------------------------------- |  | -------------------------- | ------ | ------------------------
|                                                                            |  | 2003                       |        | 2002                    
|Numerator:                                                                  |  |                            |        |                         
|Net income for basic and diluted earnings per share                         |  | $                          | 2,271  |                         
|                                                                            |  |                            |        |                         
|Denominator:                                                                |  |                            |        |                         
|Denominator for basic earnings per shareweighted-average shares            |  |                            | 38,400 |                         
|Dilutive securities: Employee stock options and purchase rights             |  |                            | 289    |                         
|                                                                            |  |                            |        |                         
|Denominator for diluted earnings per shareadjusted weighted-average shares |  |                            | 38,689 |                         
|                                                                            |  |                            |        |                         
|Basic earnings per common share                                             |  | $                          | 0.06   |                         
|                                                                            |  |                            |        |                         
|Diluted earnings per common share                                           |  | $                          | 0.06   |                         
|                                                                            |  |                            |        |                         



Note 4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 distributors. 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:



|                               |  | Three months endedJune 30, |   |  | Six months endedJune 30, |  
|------------------------------ |  | -------------------------- | - |  | ------------------------ | -
|                               |  | 2003                       |   |  | 2002                     |  
|United States                  |  | 27.7                       | % |  | 25.8                     | %
|Export:                        |  |                            |   |  |                          |  
|Asia/Pacific                   |  | 8.8                        |   |  | 11.0                     |  
|Europe, Middle East and Africa |  | 60.7                       |   |  | 56.0                     |  
|Other                          |  | 2.8                        |   |  | 7.2                      |  
|                               |  |                            |   |  |                          |  
|Total Export                   |  | 72.3                       |   |  | 74.2                     |  
|                               |  |                            |   |  |                          |  
|                               |  | 100.0                      | % |  | 100.0                    | %
|                               |  |                            |   |  |                          |  



In the three months
ended June 30, 2003, revenues from one international customer accounted for approximately 19% of total revenues. In the three months ended June 30, 2002, revenues from one international customer accounted for approximately 11% of total revenues. In
the six months ended June 30, 2003, revenues from one international customer accounted for approximately 24% of total revenues and revenues from another international customer accounted for approximately 11% of total revenues. In the six months
ended June 30, 2002, revenues from one international customer accounted for approximately 24% of total revenues.



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



Note 5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.



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
involving our current or prospective customers;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | We could be materially harmed if the market for current- and next-generation network solutions 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 Annual Report on Form 10-K filed with the SEC on



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February 28, 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



Founded in 1989, Inet Technologies, Inc. is a leading global provider of communications software solutions that enable communications carriers to more
strategically operate their businesses. We have two solution areasour Unified Assurance solutions and our Diagnostics solutions. Our Unified Assurance solutions include the GeoProbe, Orion and Beamer products, which capture signaling network
traffic and then process, correlate and analyze the raw data to create a network-wide view for troubleshooting, problem detection and network integrity assurance. These products alert carriers to network problems, such as congestion, misrouted calls
due to equipment errors, service degradation and fraud, so that action can be taken to proactively resolve issues, often before the end customer is impacted and significant revenue is lost. Our Diagnostics solutions include the Spectra2, Spectra and
Spectra Trunk Tester products, which allow communications carriers and equipment manufacturers to quickly and cost-effectively design, deploy and maintain 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 six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for
any future periods.



|                                         |  | Three months endedJune 30, |   |  | Six months endedJune 30, |  
|---------------------------------------- |  | -------------------------- | - |  | ------------------------ | -
|                                         |  | 2003                       |   |  | 2002                     |  
|Revenues:                                |  |                            |   |  |                          |  
|Product and license fees                 |  | 69.8                       | % |  | 73.4                     | %
|Services                                 |  | 30.2                       |   |  | 26.6                     |  
|                                         |  |                            |   |  |                          |  
|Total revenues                           |  | 100.0                      |   |  | 100.0                    |  
|Cost of revenues:                        |  |                            |   |  |                          |  
|Product and license fees                 |  | 24.8                       |   |  | 30.4                     |  
|Services                                 |  | 13.0                       |   |  | 12.6                     |  
|                                         |  |                            |   |  |                          |  
|Total cost of revenues                   |  | 37.8                       |   |  | 43.0                     |  
|                                         |  |                            |   |  |                          |  
|Gross profit                             |  | 62.2                       |   |  | 57.0                     |  
|Operating expenses:                      |  |                            |   |  |                          |  
|Research and development                 |  | 28.5                       |   |  | 27.8                     |  
|Sales and marketing                      |  | 14.2                       |   |  | 18.1                     |  
|General and administrative               |  | 8.1                        |   |  | 8.1                      |  
|                                         |  |                            |   |  |                          |  
|Total operating expenses                 |  | 50.8                       |   |  | 54.0                     |  
|                                         |  |                            |   |  |                          |  
|Income from operations                   |  | 11.4                       |   |  | 3.0                      |  
|Other income                             |  | 1.0                        |   |  | 4.1                      |  
|                                         |  |                            |   |  |                          |  
|Income before provision for income taxes |  | 12.4                       |   |  | 7.1                      |  
|Provision for income taxes               |  | 3.5                        |   |  | 2.0                      |  
|                                         |  |                            |   |  |                          |  
|Net income                               |  | 8.9                        | % |  | 5.1                      | %
|                                         |  |                            |   |  |                          |  



Revenues



Product and license fees.Revenues from
product and license fees decreased 7.6% to $17.8 million in the three months ended June 30, 2003 from $19.2 million in the three months ended June 30, 2002. The



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decrease in revenues from product and license fees for the three-month period ended June 30, 2003 as
compared to the prior year was primarily due to decreased revenues from our Diagnostics solutions. For this period, the average size of Diagnostics product transactions decreased by approximately 15% and the number of transactions decreased by
approximately 18%. A Diagnostics transaction is defined as a single order or unit. In the six months ended June 30, 2003, revenues from product and license fees decreased 12.3% to $35.3 million from $40.2 million in the six months ended June 30,
2002. The decline in revenues from product and license fees was primarily attributable to a decrease in the average transaction size of approximately 15% for our GeoProbe and Orion products and also due to a decrease in revenues from our Diagnostics
solutions, which was primarily driven by a decrease of approximately 11% in the number of transactions. We continue to experience 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. Although the mix of applications in a typical transaction for our GeoProbe and Orion products for which revenues were recognized in the three and six months ended June
30, 2003 was different than the mix in a typical transaction for which revenues were recognized in the three and six months ended June 30, 2002, we believe prices for our most basic GeoProbe applications have decreased by approximately 20% to 30%
for the six months ended June 30, 2003 compared to the six months ended June 30, 2002. Although the number and size of transactions may vary period to period, we believe the decrease in prices is the primary driver for the decreased transaction
size. We anticipate that we will continue to experience pricing pressures for our GeoProbe and Orion products.



Services. Revenues from services increased 10.2% to $7.7 million in the three months ended June 30, 2003 from $7.0 million in the three months
ended June 30, 2002. In the six months ended June 30, 2003, revenues from services increased 13.0% to $15.2 million from $13.5 million in the six months ended June 30, 2002. The increase in services revenues was primarily attributable to a larger
installed base of products with customers for which we provide warranty or product support services, somewhat mitigated by decreasing prices for services of approximately 10% to 15%. 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 increase.



Concentration of revenues. For the three months ended June 30, 2003, revenues from one international customer accounted for approximately 19% of total revenues. For the three months ended June 30, 2002,
revenues from one international customer accounted for approximately 11% of total revenues. For the six months ended June 30, 2003, revenues from one international customer accounted for approximately 24% of total revenues and revenues from another
international customer accounted for approximately 11% of total revenues. For the six months ended June 30, 2002, revenues from one international customer accounted for approximately 24% 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 both the three and six months ended June 30, 2003, approximately 60% 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 June 30, 2003,
international revenues accounted for approximately 72% of total revenues compared to approximately 74% of total revenues in the three months ended June 30, 2002. In the six months ended June 30, 2003, international revenues accounted for
approximately 77% of total revenues compared to approximately 76% of total revenues in the six months ended June 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



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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 $6.3 million, or 35.7% of product and license fees revenues, in the three months ended June 30, 2003, and $8.0 million, or 41.4% of product and license
fees revenues, in the three months ended June 30, 2002. The decreases in absolute dollars and as a percentage of product and license fees revenues resulted primarily from decreased hardware costs, which were approximately $1.1 million lower in the
three months ended June 30, 2003 than in the same period in the prior year, and decreased conversion costs of $0.6 million, driven by reductions in several different cost categories, including personnel, third-party installation and travel. Both the
quarter ended June 30, 2003 and the quarter ended June 30, 2002 represented periods with high hardware content transactions.



Cost of product and license fees was $9.2 million, or 26.2% of product and license fees revenues, in the six months ended June 30, 2003, and $14.2
million, or 35.3% of product and license fees revenues, in the six months ended June 30, 2002. The decreases in absolute dollars and as a percentage of product and license fees revenues resulted primarily from decreased hardware costs, which were
approximately $3.4 million lower in the six months ended June 30, 2003 than in the same period in the prior year and, to a lesser extent, decreased personnel and installation costs. The decrease in hardware costs, which was driven primarily by the
first quarter results of 2003 and 2002, is attributable to a higher percentage of our GeoProbe implementations during the six months ended June 30, 2003 being derived from expansions of existing systems or from the sales of software applications,
rather than new system implementations, which typically have a higher hardware component.



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 $3.3 million, or
42.9% of services revenues, in the three months ended June 30, 2003 and $3.3 million, or 47.3% of services revenues, in the three months ended June 30, 2002. The decrease in the percentage of total services revenues in the three months ended June
30, 2003 compared to the three months ended June 30, 2002 is attributable to increased services revenue in the current period compared to the same prior-year period and decreased personnel and warranty-related expenses. Cost of services was $7.5
million, or 49.1% of services revenues, in the six months ended June 30, 2003 and $6.5 million, or 48.0% of services revenues, in the six months ended June 30, 2002. The increases in absolute dollars and as a percentage of total services revenues in
the six months ended June 30, 2003 compared to the same period of the prior year were attributable to increased effort 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.



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 $7.3 million in both the three months ended June 30, 2003
and the three months ended June 30, 2002. Research and development



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expenses as a percentage of total revenues were 28.5% in the three months ended June 30, 2003 and 27.8%
in the three months ended June 30, 2002. For the quarter ended June 30, 2003 versus the quarter ended June 30, 2002, personnel and contract labor expenses decreased by approximately $0.4 million, reflecting decrease in average headcount of 26,
offset by increased expenses in various other categories.



In
the six months ended June 30, 2003, research and development expenses decreased to $14.9 million from $15.8 million for the comparable prior-year period. Research and development expenses as a percentage of total revenues were 29.6% for the six
months ended June 30, 2003 and 29.3% for the six months ended June 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 were approximately $0.4 million lower in the six months ended June 30, 2003 compared to the same period in the prior year. The average headcount of our research and development organization was
245 in the six months ended June 30, 2003 compared to 275 in the six months ended June 30, 2002. We do not currently expect to continue decreasing our research and development headcount. Overall, we anticipate that spending on research and
development will be flat or increase slightly in the second half 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 decreased to $3.6 million in the three months ended June 30, 2003 from $4.8 million in the three months ended June
30, 2002. Sales and marketing expenses as a percentage of total revenues were 14.2% in the three months ended June 30, 2003 and 18.1% in the three months ended June 30, 2002. The decreases in absolute dollars and as a percentage of total revenues
were primarily attributable to decreased average headcount and cost reduction efforts related to travel, tradeshows and other promotional activities. Travel expenses decreased approximately $0.1 million and expenses associated with trade shows and
other promotional activities decreased approximately $0.3 million. Average headcount in the three months ended June 30, 2003 was 66 compared to 83 in the three months ended June 30, 2002.



Sales and marketing expenses decreased to $7.1 million in the six months ended June 30, 2003 from $8.9 million for the six
months ended June 30, 2002. Sales and marketing expenses as a percentage of total revenues were 14.1% for the six months ended June 30, 2003, and 16.5% for the six months ended June 30, 2002. The decreases in absolute dollars and as a percentage of
total revenues were attributable to decreased staffing dedicated to sales and marketing activities and cost reduction efforts primarily related to travel and tradeshows and other promotional activities. Travel expenses decreased approximately $0.3
million and expenses associated with trade shows and other promotional activities decreased approximately $0.2 million. The average headcount of our sales and marketing organization was 65 in the six months ended June 30, 2003, compared to 81 in the
six months ended June 30, 2002. We currently expect to begin to increase our sales and marketing headcount. We anticipate a slight increase in sales and marketing expenses in the second half of the year, and that spending on sales and marketing may
fluctuate quarter to quarter due to seasonal spending on tradeshows, other promotional activities and the level of direct sales commissions.



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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 $2.1 million in both the three months ended June 30, 2003 and the three months ended June 30, 2002. General and
administrative expenses as a percentage of total revenues were 8.1% in both the three months ended June 30, 2003 and the three months ended June 30, 2002.



General and administrative expenses increased to $4.5 million in the six months ended June 30, 2003 from $4.1 million in the six months ended June 30,
2002. General and administrative expenses as a percentage of total revenues were 8.9% for the six months ended June 30, 2003 and 7.7% for the six months ended June 30, 2002. The increases in absolute dollars and as a percentage of total revenues
were attributable to increased professional fees of approximately $0.2 million primarily related to our repurchase of restricted common stock in January 2003 and general accounting activities. For the remainder of 2003, we expect that general and
administrative expenses will not vary significantly on an absolute dollar basis.



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 June 30,
2003, compared to $1.1 million in the three months ended June 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 June 30, 2003, we recognized a return on our average cash balance of 0.9% per annum compared to 1.6% in the same prior-year period. In the three
months ended June 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 United Kingdom and German sales and support organizations and, to a lesser extent, to the small percentage of business conducted in non-U.S. currencies.



Other income was $0.7 million in the six months ended June 30, 2003, compared to $1.6 million in the six months ended June 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 six months
ended June 30, 2003, we recognized a return on our average cash balance of 1.0% per annum compared to 1.6% in the same prior-year period. In the six months ended June 30, 2003, we recorded a foreign translation loss of $0.1 million compared to a
foreign translation gain of $0.2 million in the same prior-year period.



Provision for Income Taxes



We recorded
an income tax expense of $0.9 million for the three months ended June 30, 2003 compared to $0.5 million for the three months ended June 30, 2002. Our effective tax rates for these periods were 28.0% for the three months ended June 30, 2003 and 28.5%
for the three months ended June 30, 2002. We recorded an income tax expense of $2.4 million in the six months ended June 30, 2003 compared to $1.8 million in the six months ended June 30, 2002. Our effective tax rates for these periods were 30.5% in
the six months ended June 30, 2003 and 30.9% in the six months ended June 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 30.4%.



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Our financial statements reflect net deferred tax assets of $0.8 million as of June 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 15% to $155.4
million at June 30, 2003 from $182.5 million at December 31, 2002. We had $162.3 million in cash and cash equivalents at June 30, 2003, a decrease of $26.8 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 40% to $9.9 million for the six months ended June 30, 2003 from $16.5 million during the same period in 2002. This decrease was primarily attributable
to changes in amounts of accounts receivable, inventory, accrued compensation and benefits and other accrued liabilities in each quarter.



Net cash used in investing activities increased 72% to $2.3 million for the six months ended June 30, 2003 from $1.3 million during the same period in
2002. Net cash used in investing activities for both periods related to purchases of property and equipment. For the remainder of 2003, we anticipate that cash used in investing activities will be slightly less than cash used in investing activities
in the six months ended June 30, 2003.



Net cash used in
financing activities was $34.4 million in the six months ended June 30, 2003, compared to net cash provided by financing activities of $1.0 million in the six months ended June 30, 2002. In the six months ended June 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 June 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.



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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 Unified Assurance solutions 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, in our judgment, 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 solutions 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
Unified Assurance solutions 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 product warranty services included in initial licensing fees, are recognized ratably over the service
period. Product warranty services included in the initial licensing fee are allocated from the total contract amount based on the relative 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 determined that we do not have VSOE on an undelivered element of an arrangement, we would not be able to recognize revenue until all elements of the arrangement were 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 receivables 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



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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.



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 are determined not to be realizable. As of June 30, 2003 and December 31, 2002, a valuation for deferred tax assets was not deemed necessary. Accordingly, if the facts or financial results 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 a
decision to invest in our common stock. The risks and uncertainties described below are not the only ones we face. Additional



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risks and uncertainties that we do not presently know, or that we currently view as immaterial, may also
impair our business operations. This report is qualified in its entirety by these risk factors.



The actual occurrence of any of the following risks could materially harm our business, financial condition and 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;
| | - |  | ---------------------------------------------------------------



| |  |  | the relative mix of products fees and services fees included in our revenue;
| | - |  | ----------------------------------------------------------------------------



| |  |  | 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.
| | - |  | ----------------------------



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 adversely affected 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 the region composed of Europe, the Middle East and Africa 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 has 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 solutions and on renewals of product support agreements for our Unified Assurance solutions, which has adversely affected our revenues. In addition, our financial results historically have been influenced
by seasonal



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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.



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 three months ended June 30, 2003, approximately 60% of our revenues were derived from the
10 largest customers in the quarter, with one international customer accounting for approximately 19%. In the six months ended June 30, 2003, approximately 60% of our revenues were derived from the 10 largest customers in the period, with one
international customer accounting for approximately 24% of our total revenues and another accounting for approximately 11%. Additionally, British Telecom and Deutsche Telekom, on a combined basis, accounted for approximately 29% of total revenues in
the six months ended June 30, 2003. Although the customer make-up of our largest projects varies from quarter to quarter, a small number of significant 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 may 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.



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. 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.



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



Revenues for our Unified Assurance solutions 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



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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.



Any reversal or slowdown in the deregulation of communications markets could materially harm the demand for our
products.



Future growth in the demand for our
products will depend in part on the continued privatization, deregulation and the restructuring of communications markets worldwide, as the demand for our products has generally been higher when a relatively more competitive communications
environment exists. Any reversal or slowdown in the pace of this privatization, deregulation or restructuring could materially harm the markets for our products. Moreover, the consequences of deregulation are subject to many uncertainties, including
judicial and administrative proceedings and other regulatory, economic and political factors. Furthermore, the uncertainties associated with deregulation have in the past, and could in the future, cause our customers to delay purchasing decisions
pending the resolution of these uncertainties.



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



Sales of our Unified Assurance solutions 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 delayed or foregone. As a result of these and other factors, the sales cycle
for our solutions is long, historically ranging from six to 18 months for our Unified Assurance solutions (excluding the cycle for subsequent applications and enhancements, which varies widely) and averaging three months for occasional, large sales
of our Diagnostics solutions. 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.



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. We cannot assure you that our current or prospective customers will order these new
products and applications.



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Also, purchase decisions regarding certain new Unified Assurance 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 cannot assure you that we will be successful in developing the relationships necessary to sell
our Orion and Beamer products and applications.



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



Competition for all of our solutions is intense and is expected to continue, and in some cases intensify, in the future. We
compete 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. 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. Additionally, it is possible that new
competitors or alliances among competitors could emerge and rapidly acquire significant market share. 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. Increased competition could result in pricing pressure, reduced margins and the loss of market share. We continue to experience pressure on sales prices for our
GeoProbe product, 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 solutions and Diagnostics solutions;
| | - |  | ------------------------------------------------------------------



| |  |  | 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.



Over the long term, we expect carrier spending for legacy networks to decrease from current levels, which requires that we
develop solutions for networks based on next-generation wireless and emerging packet-based technologies and standards, such as General Packet Radio Service, or GPRS, Universal Mobile



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Telecommunications System, or UMTS, Internet Protocol, or IP, and Asynchronous Transfer Mode, or ATM. We
may not successfully develop competitive products for these 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 solutions 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.



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 we expect revenues from international markets
to continue to represent the majority of our total revenues. 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | difficulty in establishing and maintaining relationships with government-owned or subsidized communications providers;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | 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
| | - |  | ------------------------------------------------------------------------------------------------



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



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
various 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.



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.



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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 third party.



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.



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. We cannot assure you that any patent holders will not initiate legal proceedings in the future



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against us, or that if any proceedings were initiated, we would 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. We cannot assure you that any such royalty or license agreements would 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 the 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 cannot assure you
that we will be successful in protecting our proprietary technology or that our proprietary rights will 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. Although we carry insurance that mitigates our risk associated with certain product liability 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.



Our two largest stockholders own
approximately 64% of our common stock, which allows them to control the management and affairs of our company and prevent a change of control.



As of June 30, 2003, two of our founders, Samuel S. Simonian, chairman of our board, and Elie S. Akilian, president, chief executive officer and director,
collectively beneficially owned approximately 64% of the outstanding shares of our common stock. Consequently, these individuals acting together could 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 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.



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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.



We have 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 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. From July 1, 2002 through
June 30, 2003, the market price of our stock ranged from $4.00 to $10.50 per share. On a quarterly basis, the market price of our stock ranged from $4.00 to $6.68 per share from July 1, 2002 through September 30, 2002; $4.15 to $6.98 per share from
October 1, 2002 through December 31, 2002; $5.78 to $8.25 per share from January 1, 2003 through March 31, 2003; and $5.87 to $10.50 per share from April 1, 2003 through July 31, 2003. 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 and 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 and 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



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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 six
months ended June 30, 2003, approximately 2% 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.



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.



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.



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 June 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.
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | (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 June 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 June 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.



Item 4. Submission of Matters to a Vote of Security Holders



At our 2003 Annual Meeting of Stockholders held on May 12, 2003, our stockholders voted on and approved the following matters:



1. The election of two Class III directors to serve until our 2006 Annual
Meeting of Stockholders, or until their successors have been elected and qualified.



|Name of Nominee    |  | Number of Votes For |  | Number of Votes Withheld
|------------------ |  | ------------------- |  | ------------------------
|Samuel S. Simonian |  | 33,345,976          |  | 3,652,006               
|Elie S. Akilian    |  | 33,467,611          |  | 3,530,371               



2. Ratification of our
1998 Stock Option/Stock Issuance Plan.



|Number of Votes For |  | Number of Votes Against |  | Number of Votes Abstained
|------------------- |  | ----------------------- |  | -------------------------
|32,128,006          |  | 4,795,806               |  | 74,170                   



3. Ratification of the
selection of Ernst & Young LLP as our independent auditors for 2003.



|Number of Votes For |  | Number of Votes Against |  | Number of Votes Abstained
|------------------- |  | ----------------------- |  | -------------------------
|36,838,736          |  | 155,946                 |  | 3,300                    



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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 June 30, 2003 we filed a Current Report on Form 8-K on April 22, 2003. The report included information reported under Item
7Financial Statements, Pro Forma Financial Information and Exhibits and Item 9Regulation FD Disclosure (Item 12Results of Operations and Financial Condition).



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: August 5, 2003



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INET TECHNOLOGIES, INC.

INDEX TO EXHIBITS



|ExhibitNumber |  | Description                                                                                                                                                                                                       
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|              | 
|10.1          |  | Form of Indemnification Agreement between the registrant and each of its directors and executive officers                                                                                                         
|              | 
|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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