**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**ý****                                ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.**

 

**For thequarterly period ended June 30, 2004**

 

**OR**

 

**o****                                ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.**

 

**CommissionFile Number 0-24707**

** **

**INET TECHNOLOGIES, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                     | **75-2269056**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction  of incorporation or organization) | (I.R.S. employer  identification no.) |

 

 

**1500 North Greenville Avenue****Richardson, Texas 75081**

(Address of principalexecutive offices, including zip code)

 

**(469) 330-4000**

(Registrant’s telephonenumber, including area code)

 

Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90days.        Yes ý  No o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange ActRule 12b-2).  Yes ý  No o

 

Number of sharesof common stock outstanding at July 20, 2004: 39,290,774

 

 

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**Inet Technologies, Inc.**

**Index**

 
| Part  I – Financial Information |     |
|--------------------------------------|----------|
|                                 |     |   |   |
|                                 | Item  1. | Financial  Statements |   |
|                                 |     |   |   |
|                                 |     | Condensed  Consolidated Balance Sheets |   |
|                                 |     |   |   |
|                                 |     | Condensed  Consolidated Statements of Income |   |
|                                 |     |   |   |
|                                 |     | Condensed  Consolidated Statement of Stockholders’ Equity |   |
|                                 |     |   |   |
|                                 |     | Condensed  Consolidated Statements of Cash Flows |   |
|                                 |     |   |   |
|                                 |     | Notes  to Condensed Consolidated Financial Statements |   |
|                                 |     |   |   |
|                                 | Item  2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                 |     |   |   |
|                                 | Item  3. | Quantitative  and Qualitative Disclosures about Market Risk |   |
|                                 |     |   |   |
|                                 | Item  4. | Controls  and Procedures |   |
|                                 |     |   |   |
| Part  II – Other Information    |     |
|                                 |     |   |   |
|                                 | Item 2.  | Changes in Securities, Use of Proceeds  and Issuer Purchases of Equity Securities |   |
|                                 |     |   |   |
|                                 | Item 4.  | Submission of Matters to a Vote  of Security Holders |   |
|                                 |     |   |   |
|                                 | Item 6.  | Exhibits and Reports on Form 8-K |   |
|                                 |     |   |   |
| Signatures                           |     |

 

2

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**PART I.****                                                   FINANCIALINFORMATION**

 

**Item 1.****                                                          FinancialStatements**

 

**INETTECHNOLOGIES, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(Unaudited)

(Inthousands, except share data)

 
| ** **                                                                                                             | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                             |       |               |       |                   |       |
|                                                                                                                   |       |               |       |                   |       |
| Current assets:                                                                                                        |       |               |       |                   |       |
| Cash and cash equivalents                                                                                              |       | $                  | 53,784     |                   | $          | 118,527 |   |
| Short-term investments                                                                                                 |       | 119,594            |       | 55,034                 |       |
| Trade accounts receivable, net of allowance for doubtful accounts of  $514 at both June 30, 2004 and December 31, 2003 |       | 10,167             |       | 10,870                 |       |
| Unbilled receivables                                                                                                   |       | 459                |       | 146                    |       |
| Inventories                                                                                                            |       | 9,211              |       | 7,924                  |       |
| Deferred income taxes                                                                                                  |       | 1,915              |       | 1,628                  |       |
| Other current assets                                                                                                   |       | 7,237              |       | 5,055                  |       |
| Total current assets                                                                                                   |       | 202,367            |       | 199,184                |       |
| Property and equipment, net                                                                                            |       | 11,100             |       | 11,330                 |       |
| Deferred income taxes                                                                                                  |       | 324                |       | 217                    |       |
| Other assets                                                                                                           |       | 614                |       | 613                    |       |
| Total assets                                                                                                           |       | $                  | 214,405    |                   | $          | 211,344 |   |
|                                                                                                                   |       |               |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                         |       |               |       |                   |       |
|                                                                                                                   |       |               |       |                   |       |
| Current liabilities:                                                                                                   |       |               |       |                   |       |
| Accounts payable                                                                                                       |       | $                  | 2,346      |                   | $          | 1,919 |   |
| Income taxes payable                                                                                                   |       | 2,318              |       | 2,408                  |       |
| Accrued compensation and benefits                                                                                      |       | 3,782              |       | 4,115                  |       |
| Deferred revenues                                                                                                      |       | 14,868             |       | 21,554                 |       |
| Other accrued liabilities                                                                                              |       | 5,957              |       | 3,724                  |       |
| Total current liabilities                                                                                              |       | 29,271             |       | 33,720                 |       |
| 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 both June 30, 2004 and December 31, 2003     |       | 47                 |       | 47                     |       |
| Additional paid-in capital                                                                                             |       | 78,530             |       | 77,866                 |       |
| Unearned compensation                                                                                                  |       | (2,236             | )          | (2,610                 | )          |
| Retained earnings                                                                                                      |       | 140,025            |       | 134,932                |       |
| Treasury stock, 7,904,413 common shares at June 30, 2004 and 8,240,060  common shares at December 31, 2003, at cost    |       | (31,232            | )          | (32,611                | )          |
| Total stockholders’ equity                                                                                        |       | 185,134            |       | 177,624                |       |
| Total liabilities and stockholders’ equity                                                                        |       | $                  | 214,405    |                   | $          | 211,344 |   |

 

Seeaccompanying notes to our condensed consolidated financial statements.

 

3

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**INETTECHNOLOGIES, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

(Unaudited)

(Inthousands, except per share data)

 
| ** **                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended****June 30,** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **2004**                         | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                     |       |                             |       |                             |       |   |   |   |   |
| Revenues:                                |       |                             |       |                             |       |   |   |   |   |
| Product and license fees                 |       | $                                | 20,519     |                             | $          | 17,770 |   | $ | 40,166 |   | $ | 35,288 |   |
| Services                                 |       | 8,171                            |       | 7,702                            |       | 15,736 |   | 15,226 |   |
| Total revenues                           |       | 28,690                           |       | 25,472                           |       | 55,902 |   | 50,514 |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| Cost of revenues:                        |       |                             |       |                             |       |   |   |   |   |
| Product and license fees                 |       | 5,567                            |       | 6,336                            |       | 10,794 |   | 9,238 |   |
| Services                                 |       | 3,236                            |       | 3,303                            |       | 6,424 |   | 7,470 |   |
| Total cost of revenues                   |       | 8,803                            |       | 9,639                            |       | 17,218 |   | 16,708 |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| Gross profit                             |       | 19,887                           |       | 15,833                           |       | 38,684 |   | 33,806 |   |
| Operating expenses:                      |       |                             |       |                             |       |   |   |   |   |
| Research and development                 |       | 7,737                            |       | 7,257                            |       | 15,863 |   | 14,942 |   |
| Sales and marketing                      |       | 4,939                            |       | 3,608                            |       | 9,246 |   | 7,123 |   |
| General and administrative               |       | 4,565                            |       | 2,061                            |       | 6,826 |   | 4,480 |   |
|                                     |       | 17,241                           |       | 12,926                           |       | 31,935 |   | 26,545 |   |
| Income from operations                   |       | 2,646                            |       | 2,907                            |       | 6,749 |   | 7,261 |   |
| Other income (expense):                  |       |                             |       |                             |       |   |   |   |   |
| Interest income                          |       | 416                              |       | 372                              |       | 785 |   | 798 |   |
| Other expense                            |       | (243                             | )          | (125                             | )          | (398 | ) | (109 | ) |
|                                     |       | 173                              |       | 247                              |       | 387 |   | 689 |   |
| Income before provision for income taxes |       | 2,819                            |       | 3,154                            |       | 7,136 |   | 7,950 |   |
| Provision for income taxes               |       | 1,002                            |       | 883                              |       | 2,043 |   | 2,424 |   |
| Net income                               |       | $                                | 1,817      |                             | $          | 2,271 |   | $ | 5,093 |   | $ | 5,526 |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| Earnings per common share:               |       |                             |       |                             |       |   |   |   |   |
| Basic                                    |       | $                                | 0.05       |                             | $          | 0.06 |   | $ | 0.13 |   | $ | 0.14 |   |
| Diluted                                  |       | $                                | 0.05       |                             | $          | 0.06 |   | $ | 0.13 |   | $ | 0.14 |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| Weighted-average shares outstanding:     |       |                             |       |                             |       |   |   |   |   |
| Basic                                    |       | 39,221                           |       | 38,400                           |       | 39,170 |   | 39,392 |   |
| Diluted                                  |       | 39,672                           |       | 38,689                           |       | 39,739 |   | 39,609 |   |

 

Seeaccompanying notes to our condensed consolidated financial statements.

 

4

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**INET TECHNOLOGIES,INC.**

**CONDENSEDCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

(Unaudited)

(Inthousands, except share data)

 
| ** **                                                                                                    | ** ** | **Common Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Unearned  Compensation** | ** ** | **Retained  Earnings** | ** ** | **Treasury Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------|------------|----------------------------------|------------|----------------------------|------------|------------------------|------------|--------------------|------------|---------------------------------------|------------|
| ** **                                                                                                    | ** ** | ** **       | ** ** | ** **                       | ** ** | ** **                 | ** ** |
| ** **                                                                                                    | ** ** | **Shares**       | ** ** | **Amount**                       | ** ** | ** **                 | ** ** | ** **             | **Shares** | ** **         | **Amount** | ** **                            | ** ** |
|                                                                                                          |       |             |       |                             |       |                       |       |                   |       |               |       |                                  |       |   |   |   |   |
| Balance at December 31, 2003                                                                                  |       | 47,159,643       |       | $                                | 47         |                       | $          | 77,866                 |       | $                  | (2,610     | )                                     | $          | 134,932 |   | 8,240,060 |   | $ | (32,611 | ) | $ | 177,624 |   |
| Repurchase of common stock                                                                                    |       | —           |       | —                           |       | —                     |       | —                 |       | —             |       | 1,458                                 |       | (15 | ) | (15 | ) |
| Issuance of common stock under employee stock  option and stock purchase plans, including tax benefit of $436 |       | —           |       | —                           |       | 664                        |       | —                 |       | —             |       | (337,105                              | )          | 1,394 |   | 2,058 |   |
| Net income                                                                                                    |       | —           |       | —                           |       | —                     |       | —                 |       | 5,093              |       | —                                |       | — |   | 5,093 |   |
| Amortization of restricted stock awards                                                                       |       | —           |       | —                           |       | —                     |       | 374                    |       | —             |       | —                                |       | — |   | 374 |   |
| Balance at June 30, 2004                                                                                      |       | 47,159,643       |       | $                                | 47         |                       | $          | 78,530                 |       | $                  | (2,236     | )                                     | $          | 140,025 |   | 7,904,413 |   | $ | (31,232 | ) | $ | 185,134 |   |

 

Seeaccompanying notes to our condensed consolidated financial statements.

 

5

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**INETTECHNOLOGIES, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)

(Inthousands)

 
| ** **                                                                                                              | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                              | ** ** | **2004**                       | ** ** | **2003** | ** ** |
|                                                                                                                    |       |                           |       |   |   |
| **Cash flows from operating activities:**                                                                               |       |                           |       |   |   |
| Net income                                                                                                              |       | $                              | 5,093      |   | $ | 5,526 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities:                                      |       |                           |       |   |   |
| Depreciation                                                                                                            |       | 2,776                          |       | 3,577 |   |
| Amortization of purchase discounts on investments                                                                       |       | (484                           | )          | — |   |
| Stock compensation                                                                                                      |       | 374                            |       | 171 |   |
| Deferred income taxes                                                                                                   |       | (394                           | )          | — |   |
| Changes in operating assets and liabilities:                                                                            |       |                           |       |   |   |
| (Increase) decrease in trade accounts receivable                                                                        |       | 703                            |       | (3,449 | ) |
| Increase in unbilled receivables                                                                                        |       | (313                           | )          | (197 | ) |
| (Increase) decrease in inventories                                                                                      |       | (1,287                         | )          | 689 |   |
| Increase in other assets                                                                                                |       | (2,183                         | )          | (1,297 | ) |
| Increase in accounts payable                                                                                            |       | 427                            |       | 1,638 |   |
| Increase in taxes payable                                                                                               |       | 346                            |       | 582 |   |
| Decrease in accrued compensation and benefits                                                                           |       | (333                           | )          | (1,152 | ) |
| Increase (decrease) in deferred revenues                                                                                |       | (6,686                         | )          | 4,733 |   |
| Increase (decrease) in other accrued liabilities                                                                        |       | 2,233                          |       | (895 | ) |
| Net cash provided by operating activities                                                                               |       | 272                            |       | 9,926 |   |
|                                                                                                                    |       |                           |       |   |   |
| **Cash flows from investing activities:**                                                                               |       |                           |       |   |   |
| Proceeds from sales of short-term investments                                                                           |       | 55,266                         |       | — |   |
| Purchases of short-term investments                                                                                     |       | (119,342                       | )          | — |   |
| Purchases of property and equipment                                                                                     |       | (2,546                         | )          | (2,254 | ) |
| Net cash used in investing activities                                                                                   |       | (66,622                        | )          | (2,254 | ) |
|                                                                                                                    |       |                           |       |   |   |
| **Cash flows from financing activities:**                                                                               |       |                           |       |   |   |
| Repurchase of common stock                                                                                              |       | (15                            | )          | (35,553 | ) |
| Proceeds from issuance of common stock upon exercise of stock options  and purchases under employee stock purchase plan |       | 1,622                          |       | 1,117 |   |
| Net cash provided by (used in) financing activities                                                                     |       | 1,607                          |       | (34,436 | ) |
|                                                                                                                    |       |                           |       |   |   |
| Net decrease in cash and cash equivalents                                                                               |       | (64,743                        | )          | (26,764 | ) |
| Cash and cash equivalents at beginning of period                                                                        |       | 118,527                        |       | 189,076 |   |
| Cash and cash equivalents at end of period                                                                              |       | $                              | 53,784     |   | $ | 162,312 |   |
|                                                                                                                    |       |                           |       |   |   |
| **Supplemental disclosure:**                                                                                            |       |                           |       |   |   |
| Income taxes paid                                                                                                       |       | $                              | 1,799      |   | $ | 1,582 |   |

 

Seeaccompanying notes to our condensed consolidated financial statements.

 

6

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**INET TECHNOLOGIES, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

(Unaudited)

 

**Note 1 - Summary of Significant AccountingPolicies**

 

***TheCompany***

 

Inet Technologies, Inc.is a global provider of communications software products that enablecommunications carriers to more strategically and profitably operate theirbusinesses. Our Unified Assurance SolutionTM and our Diagnosticsproducts help our customers reduce capital and operating expenditures, improvecustomer acquisition and retention rates, protect and grow revenues, and morequickly and effectively develop products or services. Our products addressnext-generation networks, including mobile data and voice-over-packettechnologies, and traditional networks.

 

On June 29, 2004, weentered into an Agreement and Plan of Merger with Tektronix, Inc., orTektronix, that provides for our acquisition by Tektronix.  Consummation of the transaction is subject tovarious conditions, including our approval by stockholders and standardregulatory approvals.  At the time themerger becomes effective, each share of our common stock will be converted intothe right to receive $6.25 in cash and a fractional share of Tektronix commonstock.  The fractional share of Tektronixcommon stock to be received in the merger will be determined by an exchangeratio calculated by reference to the average of the closing sale price pershare of Tektronix common stock on the New York Stock Exchange for the fiveconsecutive trading days ending on the trading day immediately before theclosing date of the merger, referred to as the “Tektronix average price.”  If the Tektronix average price is greater thanor equal to $34.83, then the exchange ratio will be the number obtained bydividing $6.25 by $34.83, or 0.179.  Ifthe Tektronix average price is equal to or less than $28.50, then the exchangeratio will be the number obtained by dividing $6.25 by $28.50, or 0.219.  If the Tektronix average price is greaterthan the $28.50 and less than $34.83, the exchange ratio will be calculated bydividing $6.25 by the Tektronix average price. Investment banking, legal andaccounting fees associated with the transaction and incurred as of June 30,2004 of approximately $2.2 million are included in our results of operationsfor the three and six months ended June 30, 2004.  We expect to incur additional expensesrelated to this transaction totaling between $5.5 million and $6.5 million,which include banking, legal and accounting fees, certain fees related to thefiling, printing and mailing of the proxy statement/prospectus and settlementfees related to the termination of an employment arrangement for a seniormanager who was scheduled to commence employment with us subsequent to theannouncement of our acquisition by Tektronix.

 

***Consolidation***

 

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

 

***UnauditedInterim Financial Statements***

 

We have prepared theaccompanying unaudited condensed consolidated financial statements inaccordance with U.S. generally accepted accounting principles, or GAAP, forinterim financial information and the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly, thesestatements do not include all of the information and footnotes required byaccounting principles generally accepted in the United States for completefinancial statements.  In our opinion,all adjustments (consisting solely of normal recurring adjustments) necessaryfor a fair statement of the results for the interim periods presented have beenincluded.  These financial statementsshould be read in conjunction

 

7

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with the audited financial statements and relatednotes for the three years ended December 31, 2003 included in our Form 10-Kfiled with the Securities and Exchange Commission, or SEC, on January 30,2004.  Operating results for the three-and six-month periods ended June 30, 2004 are not necessarily indicative of theresults that may be expected for any other interim period or for the yearending December 31, 2004.

 

***AccountingEstimates***

 

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

 

***Basis of Presentation***

 

Certainprior period amounts have been reclassified to conform to the current periodpresentation.

 

***Cashand Cash Equivalents***

 

Cashand cash equivalents consist of bank deposits, money-market funds andcommercial paper.  All highly-liquidsecurities with original maturities of three months or less are classified ascash equivalents. The carrying value of our bank deposits and money-marketfunds approximates fair market value. Our commercial paper is classified as held to maturity and carried atamortized cost.

 

***Short-term Investments***

 

Our short-terminvestments are classified as held to maturity and carried at amortized cost.Interest income includes amortization of the purchase discounts.

 

At June 30, 2004, ourshort-term investments were as follows (in thousands):

 
| ** **                            | ** ** | **Amortized****Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|---------------------------------------|------------|-----------------------|------------|-----------------------|------------|------------------------|------------|---------------------------|------------|
| U.S. Treasury bills                   |       | $                     | 95,509     |                  | $          | 1                      |       | $                         | 61         |   | $ | 95,449 |   |
| U.S. government agency discount notes |       | 24,085                |       | —                |       | 10                     |       | 24,075                    |       |
| Total short-term investments          |       | $                     | 119,594    |                  | $          | 1                      |       | $                         | 71         |   | $ | 119,524 |   |

 

At December 31, 2003, ourshort-term investments were as follows (in thousands):

 

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

 

***Allowance for Doubtful Accounts***

 

A large portion of ourrevenues and accounts receivable are attributable to our carrier customers inthe communications industry and, to a lesser extent, to our equipmentmanufacturer customers who supply equipment into the communications industry.Our trade accounts receivable balance is recorded net of allowances for amountsnot expected to be collected from our customers. Because our accountsreceivable

 

8

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are usually unsecured, we periodically evaluate thecollectibility of our accounts based on a combination of factors, including aparticular customer’s ability to pay and the age of the receivables. Toevaluate a specific customer’s ability to pay, we analyze the customer’spayment history, if any, financial statements or other information provided bythe customer, or third-party credit analysis reports or otherpublicly-available information. In cases where the evidence suggests a customermay not be able to satisfy its obligations to us, we set up a specific reservein an amount we determine appropriate for the perceived risk. Most of ourcontracts include multiple payment milestones, some of which occur in advanceof revenue recognition, which mitigates our risk both in terms ofcollectibility and adjustments to recorded revenue. We have not historicallyexperienced significant losses on uncollectible accounts and our allowance hasbeen less than 5% of recorded receivables.

 

***Inventories***

 

Inventories are valued atthe lower of standard cost, which approximates actual cost determined on afirst-in, first-out basis, or market.  AtJune 30, 2004 and December 31, 2003, inventories consisted of the following (inthousands):

 

| ** **      | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------|------------|--------------------|------------|------------------------|------------|
|            |       |               |       |                   |       |
| Raw materials   |       | $                  | 3,177      |                   | $          | 3,498 |   |
| Work-in-process |       | 268                |       | 219                    |       |
| Finished goods  |       | 5,766              |       | 4,207                  |       |
|            |       | $                  | 9,211      |                   | $          | 7,924 |   |

 

Inventoriesare recorded net of allowances for unsalable or obsolete raw materials,work-in-process and finished goods.  On aquarterly basis, we evaluate the status of our inventory to ensure the amountrecorded in our financial statements reflects the lower of our cost or thevalue 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 forecasteddemand for the particular products incorporating inventory components.  Based on current backlog, expected orders andother expected demand, we forecast the usage of current stock.  We record reserves for obsolete andslow-moving parts of up to 100% for excess parts with insufficient demand orobsolete parts.  Amounts inwork-in-process and finished goods inventory typically relate to firm ordersand, therefore, are not subject to obsolescence risk.

 

***RevenueRecognition***

 

We derive revenues primarilyfrom product and license fees as well as services, which include training,warranty and product support services. The majority of the contracts for ourUnified Assurance products contain multiple billing milestones, such ascontract award, shipment, installation, ready for acceptance and acceptance,not all of which are associated with revenue recognition. Except as otherwisediscussed below, revenues from product and license fees are recognized in theperiod that we have completed all hardware manufacturing and/or softwaredevelopment to contractual specifications, factory testing has been completed,the product has been shipped to the customer, the fee is fixed and determinableand collection of the fee is considered probable.  When we have significant obligationssubsequent to shipment, such as installation and system integration, revenuesare recognized when there are no significant unfulfilled obligations.  Revenues from arrangements that includesignificant acceptance terms and/or provisions and revenues from arrangementsthat include significant developmental items are recognized when acceptance hasoccurred.  Revenues from our Diagnosticsproducts are typically recognized when title and risk of loss pass to thecustomer, which typically occurs at shipment. For these products, we typically have no significant obligationssubsequent to shipment.  If a significantobligation

 

9

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were to exist, we would defer revenue recognitionuntil such obligation was satisfied.  Allshipping costs are included in cost of revenues in our condensed consolidatedstatements of income.

 

Contracts for our UnifiedAssurance products typically involve multiple deliverables.  We determine the fair value of each of thecontract deliverables using vendor-specific objective evidence, or VSOE.  VSOE for each element is based on the pricefor which we would sell the element on a stand-alone basis. We offer ourcustomers product support services, which include the correction of softwareproblems, hardware replacements, telephone access to our technical personneland the right to receive unspecified product updates, upgrades andenhancements, when and if they become available.  Revenues from these services, includingpost-contract support included in initial licensing fees, are recognizedratably over the service period. Post-contract support included in the initial licensing fee is allocatedfrom the total contract amount based on the fair value of these servicesdetermined using VSOE.  Revenues fromother services, such as training, are recognized when the services have beencompleted.  If we determine that we donot have VSOE on an undelivered element of an arrangement, we will notrecognize revenue until all elements of the arrangement are delivered.

 

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

 

***Income Taxes***

 

Our income taxes arecomputed using the asset and liability method of accounting.  Under the asset and liability method, adeferred tax asset or liability is recognized for estimated future tax effectsattributable to temporary differences and carryforwards.

 

In the preparation of ourprovision for income taxes, there may be many transactions and calculationswhere the ultimate tax outcome is uncertain. The calculation of tax liabilities and the determination of whetherdeferred tax assets will be realized in full or in part involves dealing withuncertainties in the application of complex and potentially changing taxlaws.  Therefore, we must estimateseveral factors.  For example, when it ismore likely than not that all or some portion of a deferred tax asset will notbe realized, a valuation allowance must be established for the amount of thedeferred tax assets that are determined not to be realizable. As of June 30,2004 and December 31, 2003, a valuation for deferred tax assets was not deemednecessary.  If the facts underlying ourdetermination or our financial results were to change in a manner impacting thelikelihood of realizing the deferred tax assets, judgment would have to beapplied to determine the amount of valuation allowance required in any givenperiod.  Additionally, because our incometax returns are subject to review and examination in the various jurisdictionsin which we operate, the Company recognizes potential liabilities foranticipated tax issues and adjusts those potential liabilities based on anestimate of the ultimate resolution of whether, and the extent to which,additional taxes will be due.  We arecurrently not aware of any material issues that have been raised by taxingjurisdictions, and management believes that all income tax issues that may beraised as a result of such reviews and examinations in the future will beresolved with no material impact on our financial condition or results ofoperations.  However, in the event therewas an assessment by any of these jurisdictions, it could impact our taxprovision.

 

Our annual effective taxrate is currently expected to be 36.3% for the year ending December 31,2004.  This tax rate differs from the 35%statutory corporate tax rate primarily due to non-deductible costs related toour proposed acquisition by Tektronix, partially offset by the benefitsexpected to be realized from the extraterritorial income exclusion and researchand development tax credits, as well as our adjustment of certain tax accountsdue to the expiration of the statute of limitations on open tax years.  This tax rate currently reflects the impactof research and development tax credits through June 2004, at

 

10

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which time the statute expired.  As such, our effective tax rate could bepositively impacted if the research and development tax credit is reinstated.

 

During the three monthsended June 30, 2004, our effective tax rate of 35.5% was significantly impactedby non-deductible costs related to our proposed acquisition by Tektronix,partially offset by our adjustment of certain tax accounts due to theexpiration of the statute of limitations on open tax years.  These items increased our effective tax rateby 4.7 percentage points for three months ended June 30, 2004.

 

***Stock Options***

 

Wehave elected to follow Accounting Principles Board, or APB, Opinion No. 25*, Accounting for Stock Issued to Employees*, in accountingfor our employee and non-employee director stock options. Under APB 25, if theexercise price of an employee’s stock options equals or exceeds the marketprice of the underlying stock on the date of grant, no compensation expense isrecognized.  At June 30, 2004, we hadthree stock-based compensation plans covering employees and directors.  We account for stock-based compensation fornon-employees under the fair value method prescribed by Statement of FinancialAccounting Standards, or SFAS, No. 123, *Accounting for Stock-BasedCompensation*.  Through June30, 2004, there have been no grants to non-employees other than grants to ournon-employee directors under our automatic option grant program.  As of June 30, 2004, unearned stockcompensation related to restricted stock grants was approximately $2.2 million.  As of December 31, 2003, unearned stockcompensation related to restricted stock grants was approximately $2.6 million.

 

AlthoughSFAS 123 allows us to continue to follow the present APB 25 guidelines inaccounting for employee stock options and employee stock purchase rights, weare required to disclose pro forma net income and net income per share as if wehad adopted SFAS 123 in accounting for employee stock options and restrictedstock issuances and employee stock purchase rights.  The pro forma impact of applying SFAS 123 inthe three and six months ended June 30, 2004 and the three and six months endedJune 30, 2003 will not necessarily be representative of the pro forma impact infuture periods.  Our pro formainformation is as follows (in thousands, except per share data):

 
| ** **                                                                                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended****June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                               | ** ** | **2004**                         | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                     |       |                             |       |                             |       |   |   |   |   |
| Net income, as reported                                                                                  |       | $                                | 1,817      |                             | $          | 2,271 |   | $ | 5,093 |   | $ | 5,526 |   |
| Stock compensation expense recorded under the intrinsic value method,  net of income taxes               |       | 121                              |       | 21                               |       | 267 |   | 118 |   |
| Pro forma stock compensation income (expense) computed under the fair  value method, net of income taxes |       | (1,762                           | )          | 1,468                            |       | (3,748 | ) | (1,128 | ) |
| Pro forma net income                                                                                     |       | $                                | 176        |                             | $          | 3,760 |   | $ | 1,612 |   | $ | 4,516 |   |
|                                                                                                     |       |                             |       |                             |       |   |   |   |   |
| Basic earnings per common share, as reported                                                             |       | $                                | 0.05       |                             | $          | 0.06 |   | $ | 0.13 |   | $ | 0.14 |   |
| Diluted earnings per common share, as reported                                                           |       | $                                | 0.05       |                             | $          | 0.06 |   | $ | 0.13 |   | $ | 0.14 |   |
|                                                                                                     |       |                             |       |                             |       |   |   |   |   |
| Pro forma basic earnings per common share                                                                |       | $                                | 0.00       |                             | $          | 0.10 |   | $ | 0.04 |   | $ | 0.12 |   |
| Pro forma diluted earnings per common share                                                              |       | $                                | 0.00       |                             | $          | 0.10 |   | $ | 0.04 |   | $ | 0.12 |   |

 

11

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

 
| ** **                                     | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                     | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                           |       |                             |       |                           |       |   |   |   |   |
| Volatility                                     |       | 0.88                             |       | 0.95                           |       | 0.89 |   | 0.95 |   |
| Weighted-average expected lives                |       | 2.74                             |       | 3.01                           |       | 2.90 |   | 3.18 |   |
| Expected dividend yields                       |       | —                           |       | —                         |       | — |   | — |   |
| Weighted-average risk-free interest rates      |       | 2.78                             | %          | 1.55                           | %          | 2.27 | % | 1.69 | % |
| Weighted-average fair value of options granted |       | $                                | 5.76       |                           | $          | 5.27 |   | $ | 6.66 |   | $ | 4.98 |   |
|                                                |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

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

 
| ** **                                                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                    | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                          |       |                             |       |                           |       |   |   |   |   |
| Volatility                                                    |       | 0.89                             |       | 0.97                           |       | 0.91 |   | 0.98 |   |
| Weighted-average expected lives                               |       | 0.50                             |       | 0.50                           |       | 0.50 |   | 0.50 |   |
| Expected dividend yields                                      |       | —                           |       | —                         |       | — |   | — |   |
| Weighted-average risk-free interest rates                     |       | 1.04                             | %          | 1.15                           | %          | 1.15 | % | 1.32 | % |
| Weighted-average fair value of employee stock purchase rights |       | $                                | 5.95       |                           | $          | 3.35 |   | $ | 5.17 |   | $ | 2.52 |   |
|                                                               |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

**Note 2 - Related Party Transactions**

 

Epygi Technologies, Ltd.,an entity controlled by Samuel S. Simonian, one of our founders and chairman ofour board, currently performs development services for us pursuant to aconsulting agreement for which it is paid a monthly fee per full-timeprogrammer plus reimbursement of reasonable business expenses.  We expensed approximately $0.1 million forthese services in both the three months ended June 30, 2004 and the threemonths ended June 30, 2003. We expensed approximately $0.2 million for theseservices in both the six months ended June 30, 2004 and the six months endedJune 30, 2003.

 

OnJanuary 21, 2003, we repurchased in a privately-negotiated transaction8,969,984 restricted shares of our common stock from Mark A. Weinzierl, one ofour founders and a member of our board of directors until the closing of thetransaction, for an aggregate cash purchase price of approximately $35.4million. We funded the transaction with available cash.  The shares repurchased representedapproximately 19% of our total shares outstanding immediately prior to thetransaction.  Effective as of the closingof the transaction, Mr. Weinzierl resigned from our board of directors.

 

12

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**Note 3 - Earnings Per Share**

 

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

 
| ** **                                                                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                      | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                            |       |                             |       |                           |       |   |   |   |   |
| Numerator:                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Net income for basic and diluted  earnings per share                                       |       | $                                | 1,817      |                           | $          | 2,271 |   | $ | 5,093 |   | $ | 5,526 |   |
| Denominator:                                                                                    |       |                             |       |                           |       |   |   |   |   |
| Denominator for basic earnings per  share — weighted-average shares                   |       | 39,221                           |       | 38,400                         |       | 39,170 |   | 39,392 |   |
| Dilutive securities:  Employee  stock options and purchase rights                          |       | 451                              |       | 289                            |       | 569 |   | 217 |   |
| Denominator for diluted earnings  per share — adjusted  weighted-average  shares |       | 39,672                           |       | 38,689                         |       | 39,739 |   | 39,609 |   |
|                                                                                            |       |                             |       |                           |       |   |   |   |   |
| Basic earnings per common share                                                                 |       | $                                | 0.05       |                           | $          | 0.06 |   | $ | 0.13 |   | $ | 0.14 |   |
|                                                                                            |       |                             |       |                           |       |   |   |   |   |
| Diluted earnings per common share                                                               |       | $                                | 0.05       |                           | $          | 0.06 |   | $ | 0.13 |   | $ | 0.14 |   |

 

**Note 5 - Segment Information**

 

We operate in a singleindustry segment, providing communications software solutions and associatedservices to our customers through our sales personnel and certain foreignresellers.  As a result, the financialinformation disclosed in this report represents all material financialinformation related to our sole operating segment.  The geographic distribution of our revenuesas a percentage of total revenues is as follows:

 
| ** **                     | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                     | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                           |       |                             |       |                           |       |   |   |   |   |
| United States                  |       | 37.0                             | %          | 27.7                           | %          | 37.4 | % | 23.5 | % |
| Export:                        |       |                             |       |                           |       |   |   |   |   |
| Asia/Pacific                   |       | 13.6                             |       | 8.8                            |       | 9.5 |   | 8.4 |   |
| Europe, Middle East and Africa |       | 48.1                             |       | 60.7                           |       | 51.3 |   | 65.9 |   |
| Other                          |       | 1.3                              |       | 2.8                            |       | 1.8 |   | 2.2 |   |
| Total export                   |       | 63.0                             |       | 72.3                           |       | 62.6 |   | 76.5 |   |
|                           |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |

 

In the three months endedJune 30, 2004, revenues from one domestic wireline customer accounted forapproximately 13% of total revenues.  Inthe three months ended June 30, 2003, revenues from one international wirelesscustomer accounted for approximately 19% of total revenues. In the six monthsended June 30, 2004, revenues from one domestic wireline customer accounted forapproximately 12% of total revenues, revenues from one international wirelesscustomer accounted for approximately 12% of total revenues and revenues fromone international wireline customer accounted for 11% of total revenues. In thesix months ended June 30, 2003, revenues from one international wirelinecustomer

 

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accounted for approximately 24% of total revenues andrevenues from one international wireless customer accounted for approximately11% of total revenues.

 

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

 

**Item 2.**           **Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

**Forward-LookingStatements**

 

*ThisQuarterly Report on Form 10-Q contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended. All statements otherthan historical or current facts, including, without limitation, statementsabout our business strategy, plans and objectives of management and our futureprospects, are forward-looking statements. Forward-looking statements are maderegarding our business and operations without consideration of our potentialacquisition by Tektronix.  Although webelieve that the expectations reflected in such forward-looking statements arereasonable, such forward-looking statements are subject to risks anduncertainties that could cause actual results to differ materially from theseexpectations. Such risks and uncertainties include, without limitation, thefollowing:*

 

•                         *our business and stock price could be adversely affected if the mergerwith Tektronix is not completed;*

 

•                         *our operating results are difficult to predict and are likely to varysignificantly from quarter to quarter in the future;*

 

•                         *we could be materially harmed in the event of a general economicslowdown, decreased spending by communications carriers and equipmentmanufacturers or consolidations or bankruptcies involving our current orprospective customers;*

 

•                         *we could be materially harmed if demand for our products is less thanwe anticipate;*

 

•                         *we could be materially harmed if the market for current- andnext-generation network products and applications fails to develop as wecurrently anticipate;*

 

•                         *we expect to face increased competition that could result in pricereductions and reduced margins, as well as loss of market share; and*

 

•                         *other risks indicated below under the caption “Risk Factors.”*

 

*Theserisks and uncertainties are beyond our control and, in many cases, we cannotpredict the risks and uncertainties that could cause our actual results todiffer materially from those indicated by the forward-looking statements. Whenused 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 theyrelate to us or our management are intended to identify forward-lookingstatements.*

 

*Thefollowing discussion should be read in conjunction with, and is qualified inits entirety by, the condensed consolidated financial statements and notesthereto included in Item 1 of this Quarterly Report and the condensedconsolidated financial statements and notes thereto and Management’s Discussionand Analysis of Financial Condition and Results of Operations in our Form 10-Kfiled with the SEC on January 30, 2004. Historical results and percentagerelationships among any amounts in the financial statements are not necessarilyindicative of trends in operating results for any future periods.*

 

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**Overview**

 

Inet Technologies, Inc.is a global provider of communications software products that enablecommunications carriers to more strategically and profitably operate theirbusinesses. Our Unified Assurance Solution and our Diagnostics products helpour customers reduce capital and operating expenditures, improve customeracquisition and retention rates, protect and grow revenues, and more quicklyand effectively develop products or services. Our products addressnext-generation networks, including mobile data and voice-over-packettechnologies, and traditional networks.

 

This Management’sDiscussion and Analysis of Financial Condition and Results of Operations provides information that our management believesto be necessary to achieve a clear understanding of our financial statementsand results of operations.

 

Our management monitorsand analyzes a number of key performance indicators in order to manage ourbusiness and evaluate our financial and operating performance.  Those indicators include:

 

•                       *Revenues*.  We deriverevenues from product and license fees and services relating to ourproducts.  These revenues vary based onsuch factors as demand for our products, the number and size of transactionswithin the reporting period and the impact of changes in our sales prices.  In addition to monitoring the amount of ourproduct and license fees revenues, services revenues and total revenues, wealso consider revenue concentration by customer and by geographic region to bepossible indicators of current and future trends in our business.

 

•                       *Cost of revenues and gross margins*.  We strive to control our cost of revenues andthereby maintain or improve our gross margins. The major items impacting cost of product and license fees are hardwareand third-party software, personnel and overhead expenses.  Hardware and third-party software costs willvary significantly from quarter to quarter based on the relative mix ofimplementations during a reporting period. Implementations related to new systems and expansion projects involvingincreased physical network coverage involve a greater use of hardware.  In contrast, expansions of system capacityand software-only application sales require less hardware. Cost of services isdriven primarily by personnel expenses. These costs tend to fluctuate as a result of the relative mix of productsupport and training activities during a specific period.

 

•                       *Operating expenses*. Operating expenses are substantially driven by personnel and overheadexpenses. Other significant operating expenses that we monitor include travel,professional fees and facilities and communication expenses.

 

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

 

•                       *Balance sheet*.  Weview cash, short-term investments, working capital, inventory, accountsreceivable balances and days sales outstanding as important indicators of ourfinancial health.

 

15

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**Resultsof Operations**

 

***Revenues***

 

Thefollowing table sets forth, for the periods indicated, a year-over-yearcomparison of the key components of our revenues:

 
| ** **                              | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)**                | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Product and license fees                |       | $                                | 20.5       |                          | $          | 17.8                           |       | $                             | 2.7        |   | 15 | % | $ | 40.2 |   | $ | 35.3 |   | $ | 4.9 |   | 14 | % |
| Services                                |       | 8.2                              |       | 7.7                           |       | 0.5                            |       | 6                             |       | 15.7 |   | 15.2 |   | 0.5 |   | 3 |   |
| Total revenues                          |       | $                                | 28.7       |                          | $          | 25.5                           |       | $                             | 3.2        |   | 13 | % | $ | 55.9 |   | $ | 50.5 |   | $ | 5.4 |   | 11 | % |
|                                    |       |                             |       |                          |       |                           |       |                          |       |   |   |   |   |   |   |   |   |
| Top 10 customers as % of total revenues |       | 58.7                             | %          | 60.3                          | %          |                           |       |                          |       | 60.0 | % | 60.5 | % |   |   |   |   |
|                                    |       |                             |       |                          |       |                           |       |                          |       |   |   |   |   |   |   |   |   |
| Revenues from international markets:    |       |                             |       |                          |       |                           |       |                          |       |   |   |   |   |   |   |   |   |
| Asia/Pacific                            |       | 13.6                             | %          | 8.8                           | %          |                           |       |                          |       | 9.5 | % | 8.4 | % |   |   |   |   |
| Europe, Middle East and Africa          |       | 48.1                             |       | 60.7                          |       |                           |       |                          |       | 51.3 |   | 65.9 |   |   |   |   |   |
| Other                                   |       | 1.3                              |       | 2.8                           |       |                           |       |                          |       | 1.8 |   | 2.2 |   |   |   |   |   |
| Total                                   |       | 63.0                             | %          | 72.3                          | %          |                           |       |                          |       | 62.6 | % | 76.5 | % |   |   |   |   |

 

*Productand license fees. *Theincrease in product and license fees in the three months ended June 30, 2004 *compared* to the three months ended June 30, 2003 reflectedan increase in the number of Unified Assurance product implementations duringthe period of approximately 40%.  Theincrease was somewhat mitigated by a lower average value per implementation anda decrease in our sales prices compared to the same prior-year period.  Prices for our most basic GeoProbe systemgenerally decreased by approximately 8% compared to the same prior-yearperiod.  We experience the greatestpressure on sales prices in highly competitive situations involving prospectivecustomers and we anticipate that we will continue to experience pricingpressure for our products during the remainder of 2004.  The increase in product and license fees inthe three months ended June 30, 2004 compared to the three months ended June30, 2003 also reflected an increase in revenues from our Diagnostics productsof approximately 50%.

 

The increase in productand license fees in the six months ended June 30, 2004 compared to the sixmonths ended June 30, 2003 reflected an increase in the number of UnifiedAssurance product implementations during the period of approximately 55%.  The increase was somewhat mitigated by alower average value per implementation and a decrease in our sales pricescompared to the same prior-year period. Prices for our most basic GeoProbe system generally decreased byapproximately 8% compared to the same prior-year period.  The increase in product and license fees inthe six months ended June 30, 2004 compared to the six months ended June 30,2003 also reflected an increase in revenues from our Diagnostics products ofapproximately 30%.

 

*Services.*  In the three and six months ended June 30,2004 compared to the same prior-year periods, the increase in services revenueswas primarily attributable to a larger installed base of products with

 

16

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customers for which we provide product supportservices, offset by continued pressure on prices for renewals of productsupport contracts.  In the three monthsended June 30, 2004, all of our Unified Assurance product implementations werefrom expansions with existing customers. In the six months ended June 30, 2004,approximately 93% of our Unified Assurance product implementations were fromexpansions with existing customers. Going forward, we expect to sell additionalapplications to, or expand the footprint of our products with, existingcustomers and to add new customers, both of which should continue to increaseour installed base of products and corresponding services revenues. We expectthat continued sales pressure on prices may partially offset the anticipatedincrease in services revenues from expansion of our installed base.

 

*Concentrationof revenues.* In the three months ended June 30, 2004,revenues from one domestic wireline customer accounted for approximately 13% oftotal revenues.  In the three monthsended June 30, 2003, revenues from one international wireless customeraccounted for approximately 19% of total revenues. In the six months ended June30, 2004, revenues from one domestic wireline customer accounted forapproximately 12% of total revenues, revenues from one international wirelesscustomer accounted for approximately 12% of total revenues and revenues fromone international wireline customer accounted for 11% of total revenues. In thesix months ended June 30, 2003, revenues from one international wirelinecustomer accounted for approximately 24% of total revenues and revenues fromone international wireless customer accounted for approximately 11% of totalrevenues.  A large percentage of ourrevenues are typically derived from a small number of customers, the specificmake up of which typically varies from one quarter to the next.  On a quarterly basis, the 10 largestcustomers for the quarter typically account for approximately 50% to 80% oftotal revenues.  For the three monthsended June 30, 2004, approximately 59% of our revenues were derived from our 10largest customers for that period.  Weexpect these trends to continue for the foreseeable future.

 

*Internationalrevenues.* Variations in the percentage of total revenuesderived from international markets primarily occur as a result of theconcentration of revenues in a particular period from a small number ofcustomers and the economic conditions in the regions in which we operate. Forthe remainder of 2004, we expect revenues from international markets torepresent the majority of our total revenues.

 

**C*ost of Revenues***

 

Thefollowing table sets forth, for the periods indicated, a year-over-yearcomparison of the key components of our cost of revenues and gross margins:

 
| **Cost of  Revenues**    | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|--------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)** | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Product and license fees |       | $                                | 5.6        |                          | $          | 6.3                            |       | $                             | (0.7       | ) | (11 | )% | $ | 10.8 |   | $ | 9.2 |   | $ | 1.6 |   | 17 | % |
| Services                 |       | 3.2                              |       | 3.3                           |       | (0.1                           | )          | (3                            | )          | 6.4 |   | 7.5 |   | (1.1 | ) | (15 | ) |
| Total cost of revenues   |       | $                                | 8.8        |                          | $          | 9.6                            |       | $                             | (0.8       | ) | (8 | )% | $ | 17.2 |   | $ | 16.7 |   | $ | 0.5 |   | 3 | % |
|                     |       |                             |       |                          |       |                           |       |                          |       |   |   |   |   |   |   |   |   |
| Average headcount        |       | 125                              |       | 122                           |       |                           |       |                          |       | 126 |   | 121 |   |   |   |   |   |

 

17

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| **Gross  Margin**                             | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)**                      | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Product and license fees                      |       | $                                | 15.0       |                          | $          | 11.5                           |       | $                             | 3.5        |   | 30 | % | $ | 29.4 |   | $ | 26.1 |   | $ | 3.3 |   | 13 | % |
| Services                                      |       | 4.9                              |       | 4.4                           |       | 0.5                            |       | 11                            |       | 9.3 |   | 7.7 |   | 1.6 |   | 21 |   |
| Total gross margin                            |       | $                                | 19.9       |                          | $          | 15.9                           |       | $                             | 4.0        |   | 25 | % | $ | 38.7 |   | $ | 33.8 |   | $ | 4.9 |   | 14 | % |
|                                          |       |                             |       |                          |       |                           |       |                          |       |   |   |   |   |   |   |   |   |
| **Gross margin as a percentage of revenues:** |       |                             |       |                          |       |                           |       |                          |       |   |   |   |   |   |   |   |   |
| Gross margin – product and license fees  |       | 72.9                             | %          | 64.3                          | %          |                           |       |                          |       | 73.1 | % | 73.8 | % |   |   |   |   |
| Gross margin – services                  |       | 60.4                             | %          | 57.1                          | %          |                           |       |                          |       | 59.2 | % | 50.9 | % |   |   |   |   |
| Gross margin – total                     |       | 69.3                             | %          | 62.2                          | %          |                           |       |                          |       | 69.2 | % | 71.8 | % |   |   |   |   |

 

*Productand license fees.*Cost of product and license fees consistsprimarily of hardware, third-party software, personnel and overhead expensesrelated to the integration, installation and configuration of ourproducts.  In the three months ended June30, 2004 compared to the three months ended June 30, 2003, hardware costsdecreased approximately $0.8 million due to a higher percentage of our UnifiedAssurance product implementations being derived from expansions of existingsystems or from the sales of software applications than from new systemimplementations, which typically have a higher hardware component. In the sixmonths ended June 30, 2004 compared to the six months ended June 30, 2003,hardware costs increased $0.6 million. In the first three months of fiscal year 2004, hardware costs increasedapproximately $1.4 million due to a majority of our revenues being derived fromincreasing the physical network coverage of existing systems for currentcustomers, which inherently involves a greater use of hardware.  In addition, personnel costs increasedapproximately $0.3 million in the three months ended June 30, 2004 and $0.6million in the six months ended June 30, 2004 compared to the same prior-yearperiods due to increased headcount and salary adjustments. We expect a slightincrease in headcount during the remainder of 2004.

 

*Services.*Cost of services consists of expenses, primarily personnel costs, related toour product support, training and warranty activities.  In the three months ended June 30, 2004compared to the three months ended June 30, 2003, cost of services wererelatively flat.  In the six months endedJune 30, 2004 compared to the six months ended June 30, 2003, cost of servicesdecreased due to a higher percentage of man-hours being used to performproduct-related installations than service-related tasks, such as productsupport, training and warranty activities. Historically, cost of services as a percentage of services revenues hasfluctuated as a result of the relative mix of product support and trainingactivities during a specific period. We expect these fluctuations to continueinto the foreseeable future.

 

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## ***OperatingExpenses***

##  

*Researchand Development Expenses*

 

Thefollowing table sets forth, for the periods indicated, a year-over-yearcomparison of the key components of our research and development expenses:

 
| ** **                | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|---------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)**  | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Research and development  |       | $                                | 7.7        |                          | $          | 7.3                            |       | $                             | 0.4        |   | 5 | % | $ | 15.9 |   | $ | 14.9 |   | $ | 1.0 |   | 7 | % |
| Percent of total revenues |       | 27.0                             | %          | 28.5                          | %          |                           |       |                          |       | 28.4 | % | 29.6 | % |   |   |   |   |
| Average headcount         |       | 251                              |       | 244                           |       |                           |       |                          |       | 249 |   | 245 |   |   |   |   |   |
|                           |            |                                  |            |                               |            |                                |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Research and developmentexpenses consist primarily of personnel, contract labor and facilities expensesincurred by our research and development organization. Our research and development efforts include expenditures relating to newproducts and applications, and new features or enhancements for existingproducts, primarily in the areas of next-generation wireless and packet-basedtechnologies.  In the three months endedJune 30, 2004 compared to the three months ended June 30, 2003, researchand development expenses increased in absolute dollars primarily due toincreased staffing dedicated to research and development activities.   In the six months ended June 30, 2004compared to the six months ended June 30, 2003, the increase in absolutedollars was primarily due to increased staffing dedicated to research anddevelopment activities and increased use of third-party research anddevelopment services, which was approximately $0.2 million more than in thesame prior-year period.  As a percentageof total revenues, research and development expenses decreased primarily due tothe increase in total revenues.  Weexpect research and development expenses to increase slightly during theremainder of 2004 as compared to levels experienced in the first six months of2004.

 

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

 

19

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*Sales andMarketing Expenses*

 

Thefollowing table sets forth, for the periods indicated, a year-over-yearcomparison of the key components of our sales and marketing expenses:

 
| ** **                | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|---------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)**  | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Sales and marketing       |       | $                                | 4.9        |                          | $          | 3.6                            |       | $                             | 1.3        |   | 36 | % | $ | 9.2 |   | $ | 7.1 |   | $ | 2.1 |   | 30 | % |
| Percent of total revenues |       | 17.2                             | %          | 14.2                          | %          |                           |       |                          |       | 16.5 | % | 14.1 | % |   |   |   |   |
| Average headcount         |       | 78                               |       | 66                            |       |                           |       |                          |       | 75 |   | 65 |   |   |   |   |   |
|                           |            |                                  |            |                               |            |                                |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Sales and marketingexpenses consist primarily of expenses associated with personnel, includingcommissions from direct sales, travel, facilities and marketing, such as tradeshow and advertising expenses.  In boththe three months ended June 30, 2004 and the six months ended June 30, 2004compared to the same prior-year periods, the increases in sales and marketingexpenses in absolute dollars and as a percentage of total revenues wereprimarily attributable to increased personnel costs due to increased headcount,salary adjustments and increased commissions, which reflect higher bookings inthe three and six months ended June 30, 2004 compared to the same prior-yearperiods.  In addition, travel expensesincreased $0.2 million in the three months ended June 30, 2004 compared to thesame prior-year period and $0.3 million in the six months ended June 30, 2004compared to the same prior-year period.

 

General*and Administrative Expenses*

 

Thefollowing table sets forth, for the periods indicated, a year-over-yearcomparison of the key components of our general and administrative expenses:

 
| ** **                 | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|----------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)**   | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| General and administrative |       | $                                | 4.6        |                          | $          | 2.1                            |       | $                             | 2.5        |   | 119 | % | $ | 6.8 |   | $ | 4.5 |   | $ | 2.3 |   | 51 | % |
| Percent of total revenues  |       | 15.9                             | %          | 8.1                           | %          |                           |       |                          |       | 12.2 | % | 8.9 | % |   |   |   |   |
| Average headcount          |       | 47                               |       | 45                            |       |                           |       |                          |       | 46 |   | 43 |   |   |   |   |   |
|                            |            |                                  |            |                               |            |                                |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

General andadministrative expenses consist primarily of personnel, facilities andprofessional expenses of our finance and accounting, legal and executivedepartments.  The increase in absolutedollars and as a percentage of total revenues in both the three and six monthsended June 30, 2004 compared to the same prior-year periods was primarilyattributable to our expensing approximately$2.2 million for legal and investment banking fees associated with theactivities surrounding the June 29, 2004 execution of a definitive mergeragreement with Tektronix that provides for our acquisition by Tektronix.

 

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***OtherIncome***

##  

Thefollowing table sets forth, for the periods indicated, a year-over-yearcomparison of the key components of our other income:

 
| ** **                                                | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Investment income                                         |       | $                                | 0.4        |                          | $          | 0.4                            |       | $                             | —     |   | N/A |   | $ | 0.8 |   | $ | 0.8 |   | $ | — |   | N/A |   |
| Foreign currency translation loss                         |       | (0.2                             | )          | (0.1                          | )          | (0.1                           | )          | (100                          | )%         | (0.4 | ) | (0.1 | ) | (0.3 | ) | (300 | )% |
| Total other income                                        |       | $                                | 0.2        |                          | $          | 0.3                            |       | $                             | (0.1       | ) | (33 | )% | $ | 0.4 |   | $ | 0.7 |   | $ | (0.3 | ) | (43 | )% |
|                                                      |       |                             |       |                          |       |                           |       |                          |       |   |   |   |   |   |   |   |   |
| Rate of return on average cash and short-term investments |       | 1.0                              | %          | 0.9                           | %          |                           |       |                          |       | 0.9 | % | 1.0 | % |   |   |   |   |

 

Other income consistsprimarily of interest income earned on our cash and cash equivalents andinvestment income earned on our investment in U.S. Treasury bills and U.S.government agency discount notes, partially offset by foreign currencytranslation adjustments and losses on the disposal of assets.  In both the three and six months ended June30, 2004 compared to the same prior-year period, the decrease in other incomewas primarily attributable to foreign translation adjustments. Foreign currencytranslation gains or losses primarily arise from translation adjustments forour international operations, including the United Kingdom and German sales andsupport organizations and, to a lesser extent, to the small percentage of ourbusiness denominated in non-U.S. currencies. To date, we have not engaged in hedging activities for our internationaloperations or our non-U.S. dollar business.

 

## ***Provisionfor Income Taxes***

##  

Thefollowing table sets forth, for the periods indicated, a year-over-yearcomparison of our provision for income taxes:

 
| ** **               | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|--------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)** | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Income tax expense       |       | $                                | 1.0        |                          | $          | 0.9                            |       | $                             | 0.1        |   | 11 | % | $ | 2.0 |   | $ | 2.4 |   | $ | (0.4 | ) | (17 | )% |
| Effective tax rate       |       | 35.5                             | %          | 28.0                          | %          |                           |       |                          |       | 28.6 | % | 30.5 | % |   |   |   |   |
|                          |            |                                  |            |                               |            |                                |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Federal income taxes forthe periods presented have been calculated on the basis of an estimated annualrate.  Our effective tax rate during thethree and six months ended June 30, 2004 differs from the 35% statutorycorporate tax rate primarily due to the benefits expected to be realized fromthe extraterritorial income exclusion and research and development tax credits,as well as our adjustment of certain tax accounts due to the expiration of thestatute of limitations on open tax years, offset by non-deductible costsrelated to our proposed acquisition by Tektronix.  For 2004, we currently anticipate our annualeffective tax rate will be 36.3%.

 

Our financial statementsreflect net deferred tax assets of $2.2 million as of June 30, 2004, comprisedof deductible temporary differences. We have concluded that it is more likelythan not that the net

 

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deferred tax assets will be realized based on thescheduling of deferred tax amounts and projected taxable income, although wecannot assure you that such assets will be realized.  The amount of the net deferred tax assetsactually realized could vary if there are differences in the timing or amountof future reversals of existing deferred tax amounts or changes in the actualamounts of future taxable income.

 

Our anticipated annualeffective tax rate of 36.3% for 2004 differs from the 35% statutory corporatetax rate primarily due to non-deductible costs related to our proposedacquisition by Tektronix, partially offset by the benefits expected to berealized from the extraterritorial income exclusion and research and developmenttax credits, as well as our adjustment of certain tax accounts due to theexpiration of the statute of limitations on open tax years. This tax ratecurrently reflects the impact of research and development tax credits throughJune 2004, at which time the statute expired. As such, our effective tax rate could be positively impacted if theresearch and development tax credit is reinstated.

 

***Net Income***

 

Thefollowing table sets forth, for the periods indicated, a year-over-yearcomparison of our net income:

 
| ** **                | ** ** | **Three months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|---------------------------|------------|----------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)**  | ** ** | **2004**                         | ** ** | **2003**                      | ** ** | **$**                          | ** ** | **%**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Net income                |       | $                                | 1.8        |                          | $          | 2.3                            |       | $                             | (0.5       | ) | (22 | )% | $ | 5.1 |   | $ | 5.5 |   | $ | (0.4 | ) | (7 | )% |
| Percent of total revenues |       | 6.3                              | %          | 8.9                           | %          |                           |       |                          |       | 9.6 | % | 9.1 | % |   |   |   |   |
|                           |            |                                  |            |                               |            |                                |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interms of absolute dollars and as a percentage of total revenues, net incomedecreased due to our expensing approximately $2.2 million for legal andinvestment banking fees associated with the activities surrounding the June 29,2004 execution of a definitive merger agreement with Tektronix that providesfor our acquisition by Tektronix.

 

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## **Liquidity and Capital Resources**

##  

Thefollowing table sets forth, for the periods indicated, a year-over yearcomparison of key components of our liquidity and capital resources:

 
| ** **               | ** ** | **Six months ended  June 30,** | ** ** | **Variance****2004 vs. 2003** | ** ** |
|--------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **($ in millions)** | ** ** | **2004**                       | ** ** | **2003**                      | ** ** | **$** | ** ** | **%** | ** ** |
| Operating cash flows     |       | $                              | 0.3        |                          | $          | 9.9 |   | $ | (9.6 | ) | (97 | )% |
| Investing cash flows     |       | (66.6                          | )          | (2.2                          | )          | (64.4 | ) |   | * |
| Financing cash flows     |       | 1.6                            |       | (34.4                         | )          | 36.0 |   |   | ** |
|                     |       |                           |       |                          |       |   |   |   |   |
| Capital expenditures     |       | $                              | 2.5        |                          | $          | 2.3 |   | $ | 0.2 |   | 9 | % |
|                          |            |                                |            |                               |            |  |  |  |  |  |  |  |  |

 
| ** **                                                                     | ** ** | **June 30,  2004** | ** ** | **December 31,****2003** | ** ** | **$**  | ** ** | **%**  | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------|------------|--------------------------|------------|--------|------------|--------|------------|
| Cash and cash equivalents                                                      |       | $                  | 53.8       |                     | $          | 118.5  |       | $      | (64.7      | ) | (55 | )% |
| Short-term investments                                                         |       | 119.6              |       | 55.0                     |       | 64.6   |       | 117    |       |
| Accounts receivable, net                                                       |       | 10.2               |       | 10.9                     |       | (0.7   | )          | (6     | )          |
| Inventories                                                                    |       | 9.2                |       | 7.9                      |       | 1.3    |       | 16     |       |
| Working capital                                                                |       | 173.1              |       | 165.5                    |       | 7.6    |       | 5      |       |
|                                                                           |       |               |       |                     |       |   |       |   |       |
| Days sales outstanding in accounts receivable, including unbilled  receivables |       | 33.7               |       | 37.2                     |       |   |       |   |       |
| Inventory turns                                                                |       | 3.8                |       | 4.5                      |       |   |       |   |       |
|                                                                                |            |                    |            |                          |            |        |            |        |            |  |  |  |

 

----

*            The year over yearchange reflects our investment in short-term investments and as a result, thispercentage is not meaningful to the understanding of our financial conditionand results of operations.

**     This percentage is affectedby one-time transactions and is not meaningful to the understanding of ourfinancial condition and results of operations.

 

Sinceour inception, we have funded our operations and met our capital expenditure requirements primarily through cashflows from operations and to a lesser extent during our initial years ofoperations through bank borrowings.  Wehave consistently invested the proceeds from our initial public offering intemporary investments, including cash, cash equivalents and short-terminvestments.  The decrease in cash wasoffset by an increase in short-term investments due to our investment in U.S.Treasury bills and U.S. government agency discount notes with maturities greaterthan 90 days, but less than one year, which are classified as short-terminvestments.

 

Operatingcash flows in the six months ended June 30, 2004 compared to the six monthsended June 30, 2003 decreased primarily due to decreased net income and changesin deferred income taxes and deferred revenues. In the six months ended June 30, 2004, net income decreased primarilydue to our expensing approximately $2.2 million for legal and investmentbanking fees associated with the activities surrounding the June 29, 2004execution of a definitive merger agreement with Tektronix that provides for ouracquisition by Tektronix.  Deferredincome taxes were impacted by our adjustment of certain tax accounts dueto the expiration of the statute of limitations on open tax years.  The decrease in deferred revenue wasattributable to the relative mix of Unified Assurance orders currently inprocess and the related billing milestones.

 

Net cash used ininvesting activities related to purchases of short-term investments andpurchases of property and equipment.  Inthe six months ended June 30, 2004, we used $119.3 million to purchaseshort-term investments.  In the sixmonths ended June 30, 2004, we used $2.5 million to purchase

 

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property and equipment compared to $2.3 million in thesix months ended June 30, 2003.  We anticipate that cash used to purchase propertyand equipment will remain flat on a quarterly basis for the remainder of 2004from levels experienced in the current quarter.

 

Net cash provided byfinancing activities in both the six months ended June 30, 2004 and the sixmonths ended June 30, 2003 resulted from proceeds from the issuance of commonstock upon the exercise of stock options and purchases under our employee stockpurchase plan.  In the six months endedJune 30, 2003, we used approximately $35.4 million to repurchase 8,969,984restricted shares of common stock in a privately-negotiated transaction.

 

Wemay in the future pursue acquisitions of businesses, products or technologies,or enter into joint venture arrangements, that could complement or expand ourbusiness and product offerings.  Anymaterial acquisition or joint venture could result in a decrease in our workingcapital depending on the amount, timing and nature of the consideration to bepaid.  From time to time we also considervarious other alternatives to utilize any cash and cash equivalents that exceedour working capital requirements, including payment of cash dividends,additional stock repurchases or other similar transactions.

 

At June30, 2004, we had no long-term debt. Webelieve that our current cash balances and expected future cash flows will besufficient to meet our anticipated cash needs for working capital, capitalexpenditures 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 additionalequity or debt financing. In addition, any material acquisition of otherbusinesses, products or technologies or material investments in joint venturescould require us to obtain additional equity or debt financing. There can be noassurance that additional financing would be available on acceptable terms, ifat all.

 

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

 

Itis not our usual business practice to enter into off-balance sheetarrangements, except for off-balance sheet arrangements related to inventorypurchase commitments and operating lease commitments, as disclosed in the tableof contractual obligations below.  Inaddition, it is not our normal policy to issue guarantees to third parties.

 

Weare obligated to make future payments under various contracts, includingnon-cancelable inventory purchase commitments and the operating leases for ourcorporate office facility and our facilities in Milan, Italy and near thecities of London, England; Frankfurt, Germany and Paris, France. The followingtable summarizes our contractual cash obligations as of June 30, 2004 (inthousands):

 

 
| ** **           | ** ** | **Remainder of****2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **Thereafter** | ** ** |
|----------------------|------------|--------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Purchase commitments |       | $                        | 6,618      |     | $          | 937      |       | $        | —     |     | $          | —         |       | $ | — |   | $ | — |   |
| Capital commitments  |       | 268                      |       | —   |       | —   |       | —   |       | —   |       | —         |       |
| Operating leases     |       | 3,074                    |       | 6,287    |       | 6,358    |       | 6,358    |       | 6,358    |       | 11,614         |       |
| Total                |       | $                        | 9,960      |     | $          | 7,224    |       | $        | 6,358      |     | $          | 6,358          |       | $ | 6,358 |   | $ | 11,614 |   |

 

Duringthe remainder of 2004, we expect quarterly capital expenditures to remainrelatively flat compared to the level experienced in the current quarter.

 

**Related Party Transactions**

 

Epygi Technologies, Ltd.,an entity controlled by Samuel S. Simonian, one of our founders and chairman ofour board, currently performs development services for us pursuant to aconsulting agreement

 

24

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for which it is paid a monthly fee per full-timeprogrammer plus reimbursement of reasonable business expenses.  We expensed approximately $0.1 million forthese services in both the three months ended June 30, 2004 and the threemonths ended June 30, 2003. We expensed approximately $0.2 million for theseservices in both the six months ended June 30, 2004 and the six months endedJune 30, 2003.

 

OnJanuary 21, 2003, we repurchased in a privately-negotiated transaction8,969,984 restricted shares of our common stock from Mark A. Weinzierl, one ofour founders and a member of our board of directors until the closing of thetransaction, for an aggregate cash purchase price of approximately $35.4 million. We funded the transaction with availablecash.  The shares repurchased representedapproximately 19% of our total shares outstanding immediately prior to thetransaction.  Effective as of the closingof the transaction, Mr. Weinzierl resigned from our board of directors.

 

**Accounting Policies**

 

Inpreparing our condensed consolidated financial statements in conformity withU.S. generally accepted accounting principles, we use certain estimates and assumptions that affect the reported amounts and relateddisclosures and may vary from actual results. We consider the following accounting policies as those most important tothe portrayal of our financial condition and those that require the mostjudgment 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 ourfinancial results.

 

***Revenue Recognition***

 

*General.*Wederive revenues primarily from product and license fees as well as services,which include training, warranty and product support services. The majority ofthe contracts for our Unified Assurance products contain multiple billingmilestones, such as contract award, shipment, installation, ready foracceptance and acceptance, not all of which are associated with revenuerecognition. Except as otherwise discussed below, revenues from product andlicense fees are recognized in the period that we have completed all hardwaremanufacturing 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 consideredprobable.  When we have significantobligations subsequent to shipment, such as installation and systemintegration, revenues are recognized when there are no significant unfulfilledobligations.  Revenues from arrangementsthat include significant acceptance terms and/or provisions and revenues fromarrangements that include significant developmental items are recognized whenacceptance has occurred.  Revenues fromour Diagnostics products are typically recognized when title and risk of losspass to the customer, which typically occurs at shipment.  For these products, we typically have nosignificant obligations subsequent to shipment. If a significant obligation were to exist, we would defer revenuerecognition until such obligation was satisfied.  All shipping costs are included in cost ofrevenues in our condensed consolidated statements of income.

 

*Multiple-elementarrangements.*Contracts for our Unified Assurance productstypically involve multiple deliverables. We determine the fair value of each of the contract deliverables usingvendor-specific objective evidence, or VSOE. VSOE for each element is based on the price for which we would sell theelement on a stand-alone basis. We offer our customers product supportservices, which include the correction of software problems, hardwarereplacement, telephone access to our technical personnel and the right toreceive unspecified product updates, upgrades and enhancements, when and ifthey become available.  Revenues fromthese services, including post-contract support included in initial licensingfees, are recognized ratably over the service period.  Post-contract support included in the initiallicensing fee are allocated from the total contract amount based on the fairvalue of these services determined using VSOE. Revenues from other services, such as training, are recognized when theservices have been completed. If we determine that we do not have VSOE on anundelivered element of

 

25

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an arrangement, we will not recognize revenue untilall elements of the arrangement are delivered. This occurrence could materially impact our financial results because ofthe significant dollar amount of many of our contracts and the significantportion of total revenues that a single contract may represent in anyparticular period.

 

***Trade Accounts Receivable and Allowance for Doubtful Accounts***

 

A large portion of ourrevenues and accounts receivable are attributable to our carrier customers inthe communications industry and, to a lesser extent, to our equipmentmanufacturer customers who supply equipment into the communications industry.Our trade accounts receivable balance is recorded net of allowances for amountsnot expected to be collected from our customers. Because our accountsreceivable are usually unsecured, we periodically evaluate the collectibilityof our accounts based on a combination of factors, including a particularcustomer’s ability to pay and the age of the receivables. To evaluate aspecific customer’s ability to pay, we analyze the customer’s payment history,if any, financial statements or other information provided by the customer, orthird-party credit analysis reports or other publicly-available information. Incases where the evidence suggests a customer may not be able to satisfy itsobligations to us, we set up a specific reserve in an amount we determineappropriate for the perceived risk. Most of our contracts include multiplepayment milestones, some of which occur in advance of revenue recognition,which mitigates our risk both in terms of collectibility and adjustments torecorded revenue. We have not historically experienced significant losses onuncollectible accounts and our allowance has been less than 5% of recordedreceivables.

 

***InventoryReserves***

 

Inventoriesare recorded net of allowances for unsalable or obsolete raw materials,work-in-process and finished goods.  Weevaluate on a quarterly basis the status of our inventory to ensure the amountrecorded in our financial statements reflects the lower of our cost or thevalue we expect to receive when we sell the inventory.  This estimate is based on several factors, includingthe condition and salability of our inventory and the forecasted demand for theparticular products incorporating inventory components.  Based on current backlog, expected orders andother expected demand, we forecast the usage of current stock.  We record reserves for obsolete and slow-movingparts of up to 100% for excess parts with insufficient demand or obsoleteparts.  Amounts in work-in-process andfinished goods inventory typically relate to firm orders and, therefore, arenot subject to obsolescence risk. If market conditions deteriorate or theexpected future demand for our products otherwise decreases, or if changes inour business strategy reduce our need for these components, our estimate of thecarrying value of our inventory could be reduced by a material amount.

 

***Income Taxes***

 

In the preparation of ourprovision for income taxes and determination of whether deferred tax assetswill be realized in full or in part, we must estimate several factors.  When it is more likely than not that all orsome portion of the deferred tax asset will not be realized, a valuationallowance must be established for the amount of the deferred tax assets that isdetermined not to be realizable. As of June 30, 2004 and December 31, 2003, avaluation for deferred tax assets was not deemed necessary.  If the facts underlying our determination orfinancial results on which our estimates are based were to change in a mannerimpacting the likelihood of realizing the deferred tax assets, judgment wouldhave to be applied to determine the amount of valuation allowance required inany given period.  Additionally, ourincome tax returns are subject to review and examination in the variousjurisdictions in which we operate.  Weare currently not aware of any material issues that have been raised by taxingjurisdictions, and management believes that all income tax issues which may beraised as a result of such reviews and examinations in the future will beresolved with no material impact on our financial condition or future resultsof

 

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operations. However, in the event there was an assessment by any of thesejurisdictions, it could impact our tax provision.  In addition, we review the tax provision on acomponent basis and reflect changes in estimates in the period in which theyare identified.  The tax provision isbased on tax statutes in effect as of the date of the balance sheet.

 

**RiskFactors**

 

*Youshould carefully consider the risks described below before making an investmentdecision regarding our common stock. The risks and uncertainties describedbelow are not the only ones facing us. Additional risks and uncertainties thatwe do not presently know or that we currently deem immaterial may also impairour business operations. This document is qualified in its entirety by theserisk factors.*

 

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

 

***Our business and stock price may be adversely affected ifthe proposed acquisition by Tektronix is not completed.***

 

On June 29, 2004, weentered into an Agreement and Plan of Merger with Tektronix that provides forour acquisition.  The announcement ofthis transaction and the activities that we are undertaking now or mayundertake in the future in anticipation of the closing of the transactionsubject us to a number of risks which, if the transaction were not completed,could adversely affect our business and stock price.  These activities have resulted in significantdiversion of management and other employees’ attention from Inet’s day-to-daybusiness and a similar disruption to its employees in general, and there is thepotential of employee turnover driven by the uncertainties from the impact ofthe merger.  Our relationships with ourcustomers could be harmed as a result of uncertainties relating to theanticipated merger and result in potential delays in purchases from customers asthey assess the potential combination. This would detract from our ability to grow revenues, which, in turnmight lead to a loss of market position that we could be unable to regain ifthe merger does not occur.  Additionally,were the transaction not completed, we would not realize the benefits we expectby being part of a combined company with Tektronix.  Our stock price could decline to the extentthat the current market price of those shares reflects a market assumption thatthe merger will be completed or as a result of the other factors describedabove.

 

In connection with theproposed merger, Inet and Tektronix have filed with the Securities and ExchangeCommission a Registration Statement on Form S-4, which contains a proxystatement/prospectus.  WE URGE INET STOCKHOLDERSAND INVESTORS TO READ THE PROXY STATEMENT/PROSPECTUS BECAUSE IT CONTAINSIMPORTANT INFORMATION ABOUT INET, TEKTRONIX AND THE PROPOSED MERGER, RISKSRELATING TO THE MERGER AND THE COMBINED COMPANY, AND RELATED MATTERS.  The proxy statement/prospectus, including theannexes attached to, and the reports incorporated by reference in, the proxystatement/prospectus, and any other reports and documents filed by Inet orTektronix with the SEC, may be obtained free of charge at the SEC’s web site atwww.sec.gov.

 

***Ourquarterly financial results fluctuate and are difficult to predict.***

 

Our quarterly financialresults have varied significantly in the past and are likely to varysignificantly from quarter to quarter in the future based on a number offactors, many of which are outside of our control. As a result, you should notrely on our results of operations during any particular quarter as anindication of our future performance in any quarterly period or fiscal year.The factors that could affect our quarterly financial results include:

 

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•                      the timingor occurrence of the consummation of our announced acquisition by Tektronix;

 

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

 

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

 

•                      the timingof our development and introduction of new products or applications;

 

•                      the relativemix of product and license fees and services fees included in our revenues;

 

•                      the relativemix of hardware- and software-related revenues in our total revenues;

 

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

 

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

 

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

 

•                      other risksdescribed below.

 

A significant portion ofour operating expenses, including rent and salaries, is largely fixed innature. Accordingly, if revenues are below expectations, our financial resultsare likely to be adversely and disproportionately affected because theseoperating expenses are not variable in the short term and cannot be quicklyreduced to respond to unanticipated decreases in revenues.

 

Our financial results arealso likely to fluctuate due to factors that impact our current and prospectivecustomers. Expenditures by customers tend to vary in cycles that reflectoverall economic conditions, individual budgeting and buying patterns and, insome cases, the ability of some of our customers to obtain the financing theyrequire to make capital expenditures. Our business has been harmed by a softeconomy, and we would be further harmed by a decline in the economic prospectsof our customers or the economy in general. This harm would be exacerbated by adecline in the economic prospects of our current and prospective customers inEurope, as revenues from this region have historically represented the majorityof our total revenues. In many cases, these adverse economic conditions havealtered current and prospective customers’ capital spending priorities orbudget cycles, which have extended our sales cycle. These adverse effects couldcontinue and could impact our customers’ ability to meet their financialobligations to us. Our business also could be harmed by changes in customerspending patterns reflecting industry trends. For example, customer budgetaryconstraints have contributed to downward sales price pressure on some of ourproducts and on renewals of product support agreements for our UnifiedAssurance products, which have adversely affected our revenues.  In addition, our financial resultshistorically have been influenced by seasonal fluctuations, with orders tendingto be strongest in the fourth quarter of each year and orders in our firstquarter 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 capitalappropriation practices of many of our customers.

 

As a result of all of theforegoing, we cannot assure you that our revenues will grow or remain stable infuture periods or that we will remain profitable. In addition, in some futurequarters our financial results may be below the expectations of public marketanalysts or investors. In such event, the market price of our common stockwould likely fall.

 

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***Reducedcommunications spending, or consolidations or bankruptcies in thecommunications industry, could harm our business, financial condition andresults of operations.***

 

We have derivedsubstantially all of our revenues from sales of products and related servicesto the communications industry. Since early 2001, we and a number of othercompanies have been impacted by reduced spending by communications carriers andequipment manufacturers, and, although spending levels for future periods aredifficult to predict, it is generally perceived that conditions areimproving.  Our business, financialcondition and results of operations could be materially harmed in the eventthat economic or business conditions in our industry do not continue toimprove. We could also be impacted in the event that there are consolidationsof our current customers, which could result in the displacement of ourproducts by a competitor’s products preferred by the other party to theconsolidation, or bankruptcies of our current or prospective customers, whichcould result in reduced revenues or significant write-offs of uncollectibleaccounts receivable. Additionally, decreases in spending often cause delays insales and installations and could cause cancellations of current or plannedprojects, any of which could harm our financial results in a particular period.

 

***Ourfinancial results could be materially harmed if demand for our new products isless than we anticipate or the performance of our products falls below thelevels required by our customers.***

 

A key component of ourstrategy is the ability to successfully develop, introduce and market newUnified Assurance and Diagnostics products and applications. Although we haveobtained input from our customers and potential customers regarding our developmentand product strategy, we have made certain assumptions as to the needs of ourcustomers and the features, functionality and performance expected by them. Ourcurrent or prospective customers may not order these new products andapplications.

 

Also, purchase decisionsregarding certain of our Unified Assurance products and applications may beinfluenced or made by individuals within organizations with which we have nosignificant existing relationships, such as customer service, sales andmarketing, or information technology departments. We may not be successful indeveloping the relationships necessary to sell certain of our Unified Assuranceproducts and applications.

 

In addition to theservice quality management features of our Unified Assurance products,communications carriers also require systems to manage the quality of serviceof the other aspects of their customer-related activities, such as billing,trouble ticket management and inventory control.  As a result, in certain cases a communicationscarrier may seek the functionality that we offer as a component of a broaderservice quality management system, addressing all of these quality managementneeds, rather than through specific offerings from multiple vendors.  In such cases, and as a result of thecomplexity surrounding the integration of these various functionalities, theopportunity to provide these systems may only be offered to our competitors whohave a broader product offering or to system integrators who would develop suchfunctionality internally or purchase it from other vendors.  We cannot assure you that we would beconsidered by these system integrators to provide our products as part of theoverall service quality management system.

 

***Ourrevenues are highly concentrated among a small number of customers.***

 

A large percentage of ourrevenues are typically derived from a small number of customers, and we expectthis trend to continue. For example, in the three months ended June 30, 2004,approximately 59% of our revenues were derived from our 10 largest customers inthe period, with one customer accounting for more than 13% of totalrevenues.  In the six months ended June30, 2004, approximately 60% of our revenues were derived from our 10 largestcustomers in the period, with three customers each accounting for more than 10%of total revenues.  On a combined basis,our three 10% customers in this six-month

 

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period accounted for approximately 35% of our totalrevenues.  Although the customer make-upof our largest projects varies from quarter to quarter, a small number ofsignificant repeat customers frequently account for a significant portion ofour revenues in a given period. If we were to lose one or more of oursignificant repeat customers, our financial results could be harmed.Additionally, if one or more of these significant repeat customers experiencesadverse conditions in its industry or operations, including the impact of anyeconomic downturn or reduction in communications spending, these customers maynot be able to meet their ongoing financial obligations to us or purchaseadditional products.

 

***Changesor delays in the implementation or customer acceptance of our products couldharm our financial results.***

 

Revenues for our UnifiedAssurance products, which account for the majority of our total revenues, aretypically recognized upon the completion of system installation or customeracceptance. Delays caused by us or our customers in the commencement orcompletion of scheduled product installations and acceptance testing may occurfrom time to time due to site-readiness delays, the often comprehensiveprocesses for testing and acceptance required by certain of our customers,insufficient personnel on the part of us or our customers to complete aproject, the lengthening of implementation schedules due to the introduction ofnew features or applications, or other issues. Because a significant portion ofour total revenues on a quarterly basis is derived from a small number ofcustomer projects, product installation delays could materially harm ourfinancial results for a particular period. With respect to contracts providingfor a significant payment or performance milestone tied to customer acceptanceor allowing customer return, termination or similar rights prior to acceptance,we generally do not recognize revenue until acceptance is achieved. For newproducts, we typically recognize revenue initially upon acceptance. As aresult, in cases where the recognition of revenue is tied to customeracceptance, the failure to obtain acceptance or delayed acceptance could harmour financial results for a particular period. Additionally, we may be subjectto penalties or other customer claims for a failure to meet contractually agreedupon milestones or deadlines.

 

***Thesales cycle for our products is long, which could harm our quarterly financialresults.***

 

Sales of our UnifiedAssurance products, which since 1998 have accounted for the majority of ourtotal revenues, are made predominantly to large communications carriers andinvolve significant capital expenditures as well as lengthy sales cycles andimplementation processes. Sales to this type of customer generally require anextensive sales effort throughout the customer’s organization and finalapproval by an executive officer or other senior-level approval. We expendsubstantial funds and management effort pursuing these sales. Additionally,potential customers often maintain comprehensive processes for internalapproval, contracting and procurement, which may cause potential sales to bedelayed or foregone. As a result of these and other factors, the sales cyclefor our products is long, historically ranging from six to 18 months for ourUnified Assurance products (excluding the cycle for subsequent applications andenhancements, which varies widely) and averaging three months for occasional,large sales of our Diagnostics products. Accordingly, our ability to forecastthe timing and amount of specific sales is limited, and the deferral or loss ofone or more significant sales could materially harm our financial results in aparticular quarter, especially if there are significant sales and marketingexpenses associated with any deferred or lost sales.

 

***Competitionis intense, may intensify and could result in increased downward pricingpressure, reduced margins and the loss of market share.***

 

Competition for all ofour products is intense, is expected to continue and in some cases mayintensify. We compete principally with a number of U.S. and internationalhardware and software suppliers that vary in size and in the scope and breadthof the products and services offered. We compete

 

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to a lesser extent with systems integrators and withthe internal development organizations of current and prospective customers.Certain of our competitors have, in relation to us, longer operating histories,larger installed customer bases, longer-standing relationships with customers,greater name recognition and significantly greater financial, technical,marketing, customer service, public relations, distribution and otherresources. As a result, these competitors may be able to more quickly developor adapt to new or emerging technologies and changes in customer requirements,or devote greater resources to the development, promotion and sale of theirproducts. Additionally, it is possible that new competitors or alliances amongcompetitors could emerge and rapidly acquire significant market share. Increasedcompetition could result in increased downward pricing pressure, reducedmargins and the loss of market share. We continue to experience pressure onsales prices for our most basic GeoProbe system and certain of our Orionapplications, especially for those applications for which there is acompetitive offering, or in highly competitive situations involving prospectivecustomers.

 

***Ourbusiness depends on retaining our existing key personnel.***

 

Our business depends to asignificant extent upon the continued service and performance of a relativelysmall number of key senior managers, technical personnel and sales andmarketing personnel, few of whom are bound by an agreement to remain in ouremploy. 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.

 

***Wemay be unable to adapt to rapid technological change and evolving customerrequirements.***

 

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

 

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

 

•                      enhance ourUnified Assurance and Diagnostics products;

 

•                      keep pacewith evolving industry protocol standards, next-generation technologies andchanging customer needs;

 

•                      establishand maintain interoperability between our products and the third-party productsforming other components of our customers’ operation support systems; and

 

•                      achievebroad market acceptance for our products.

 

We cannot assure you thatwe will achieve these objectives.

 

Over the long term, weexpect carrier spending for traditional networks to continue to decrease, whichrequires that we continue to develop products and applications for networksbased on emerging next-generation wireless and packet-based technologies andstandards. We may not successfully develop or acquire additional competitiveproducts for these emerging technologies and standards.

 

Products as complex asthose currently under development by us frequently are subject to delays, andwe cannot assure you that we will not encounter difficulties, such as theinability to assign a sufficient number of qualified technical personnel to keyprojects or other unanticipated causes, that could delay or prevent thesuccessful and timely development, introduction and marketing of thesepotential new

 

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products. Even if such potential new products aredeveloped and introduced, we cannot assure you that they will achieve anysignificant degree of market acceptance. In addition, our products areimplemented with our purpose-specific hardware platform and certain third-partyhardware and software. We cannot assure you that we will be able to design andmanufacture, or procure from third parties, the hardware and software necessaryto successfully implement our new products and applications.

 

***Amajority of our revenues have historically come from our internationalcustomers, and, as a result, our business may be harmed by political andeconomic conditions in foreign markets and the challenges associated withoperating internationally.***

 

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

 

•                      managementof our geographically dispersed operations;

 

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

 

•                      greater difficultyin evaluating a customer’s ability to pay, longer accounts receivable paymentcycles and greater difficulty in the collection of past-due accounts;

 

•                      generaleconomic conditions in each country;

 

•                      currencycontrols and exchange rate fluctuations;

 

•                      challengesassociated with operating in diverse cultural and legal environments;

 

•                      seasonalreductions in business activity specific to certain markets;

 

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

 

•                      foreigntaxes and the overlap of different tax structures, including modifications tothe U.S. tax code as a result of international trade regulations;

 

•                      greaterdifficulty in safeguarding intellectual property;

 

•                      import andexport licensing requirements and other trade restrictions;

 

•                      involuntaryrenegotiation of contracts with foreign governments and communicationscarriers; and

 

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

 

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***Wemay be unable to produce sufficient quantities of our products because weobtain various key components from sole and limited source suppliers. If we areunable to obtain these components, or if the prices of these componentsincrease, we could be unable to ship our products in a timely manner or ourproduct costs could be materially impacted.***

 

We could experiencedelays or reductions in product shipments or increases in product costs if weare unable to obtain sufficient key components as required or to developalternative sources if and as required in the future. Currently, our productsutilize certain components that are available from only one or a limited numberof suppliers. While alternative suppliers have been identified for a variety ofkey components, those alternative sources have not been qualified or activatedby us. Our qualification process could be lengthy, and we cannot assure youthat additional sources would become available to us on a timely basis, or ifsuch sources were to become available, that the components would be comparablein price and quality to our current components. We generally do not execute long-termsupply agreements with our suppliers and, in the case of many components, makeour purchases with purchase orders on an “as-needed basis.” Some of thecomponents our products utilize require long order lead-times, in certain casesup to nine months. Other components that currently are readily available maybecome difficult to obtain in the future. Our failure to order sufficientquantities of these components in advance of product delivery deadlines couldprevent us from adequately responding to unanticipated increases in customerorders. In the past, we have experienced delays in the receipt of a variety ofour key components, which have resulted in delays in product deliveries. Inaddition, the cost of various key components of our products has fluctuatedsignificantly in the past based on supply and demand factors. Significantchanges in supply and demand characteristics in the future could cause the costof various components to increase, which could adversely impact our productcosts.

 

***Keycomponents used in our products may become obsolete. If we are unable to findand design in replacement parts, we may be unable to ship our products insufficient quantities.***

 

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

 

***Ourinventory may become obsolete or unusable.***

 

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

 

***Werely in part on third-party subcontractors in the manufacture and developmentof our products. Our ability to sell products to our customers could beimpaired if these subcontractors do not meet their commitments to us.***

 

Any disruption in ourrelationships with third-party subcontractors and our inability to developalternative sources if and as required in the future could result in delays orreductions in product

 

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

 

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

 

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

 

***Ourstrategy may require that we pursue acquisitions, joint ventures or otherbusiness relationships.  We may notsuccessfully develop these relationships to support our strategy or we may notreceive the intended benefits of any future acquisitions, joint ventures orother business relationships.***

 

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

 

The negotiation ofpotential acquisitions or strategic relationships, as well as the integrationof an acquired or jointly developed business, technology or product, couldcause diversion of management’s time and resources. Future acquisitions andstrategic relationships by us could result in potentially dilutive issuances ofequity securities, a material reduction in cash reserves, the incurrence of debtand contingent liabilities, research and development write-offs and otheracquisition-related expenses. We cannot assure you that any acquisition orjoint venture will be successfully integrated with our operations. If we wereto pursue any such acquisition or strategic relationship, we may not receivethe intended benefits of the acquisition or strategic relationship.

 

***Wemay be accused of infringing the proprietary rights of others, which couldsubject us to costly and time-consuming litigation.***

 

The communicationsindustry is characterized by the existence of a large number of patents andfrequent allegations of patent infringement. In the past, we have received, andmay receive in the future, notices from holders of patents that raise issues asto possible infringement by our products. As the

 

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number of competitive products increases and thefunctionality of these products further overlaps, we believe that we may becomeincreasingly subject to allegations of infringement. Questions of infringementand the validity of patents in the field of communications signalingtechnologies involve highly technical and subjective analyses. Patent holdersmay initiate legal proceedings in the future against us, and if any proceedingsare initiated, we may not be successful in defending ourselves. Any claim orproceeding could be time consuming and expensive to defend or resolve, resultin substantial diversion of management resources, cause product shipment delays,or force us to enter into royalty or license agreements rather than dispute themerits of any such claim made or proceeding initiated against us. Any suchroyalty or license agreements may not be available on terms acceptable to us,if at all.

 

***Ourlimited ability or failure to protect our intellectual property may materiallyharm our ability to compete.***

 

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

 

***Wemay face potential liability for product defects.***

 

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

 

***Ourbusiness and reputation could suffer if we do not prevent security breaches.***

 

We have included securityfeatures in some of our products that are intended to protect the privacy andintegrity of customer data. Despite the existence of these security features,our products may be vulnerable to breaches in security due to unknown defectsin the security mechanisms, as well as vulnerabilities inherent in theoperating system or hardware platform on which the product runs and/or the networkslinked to that platform. Security vulnerabilities, regardless of origin, couldjeopardize the

 

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security of information stored in and transmittedthrough the computer systems of our customers. Any security problem may requiresignificant capital expenditures to solve and could materially harm ourreputation and product acceptance.

 

***Ourtwo largest stockholders own approximately 39% of our common stock, which givesthem effective control over the management and affairs of our company and coulddelay or prevent a change of control.***

 

Two of our founders,Samuel S. Simonian, chairman of our board, and Elie S. Akilian, our presidentand chief executive officer and a director, collectively beneficially own approximately39% of the outstanding shares of our common stock. Consequently, if theseindividuals were to act together, they could effectively control the outcome ofall matters submitted for stockholder action, including the election of ourboard of directors and the approval of significant corporate transactions. Theyalso effectively control the management and affairs of our company, which couldhave 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 takenby our board.

 

***Wehave previously adopted anti-takeover defenses that could delay or prevent anacquisition of our company.***

 

Our certificate ofincorporation and bylaws and Delaware law contain provisions that may have theeffect of discouraging, delaying or preventing a change in control of ourcompany or unsolicited acquisition proposals that a stockholder may considerfavorable. For example, we have a classified board of directors with staggered,three-year terms, our stockholders are unable to take action by writtenconsent, our stockholders are limited in their ability to make proposals atstockholder meetings, and our board of directors is empowered to issueblank-check preferred stock without any need to obtain stockholder approval.

 

***Volatilityin our stock price could result in claims against us.***

 

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

 
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2004**       |       |     |       |    |       |
| Second Quarter |       | $        | 12.61      |    | $          | 8.44 |   |
| First Quarter  |       | 17.20    |       | 10.76   |       |
|           |       |     |       |    |       |
| **2003**       |       |     |       |    |       |
| Fourth Quarter |       | $        | 14.60      |    | $          | 11.09 |   |
| Third Quarter  |       | 16.00    |       | 9.76    |       |
| Second Quarter |       | 10.50    |       | 5.87    |       |
| First Quarter  |       | 8.25     |       | 5.78    |       |

 

Our stock price may be significantly affected byfactors such as:

 

•                      the failureto consummate our proposed acquisition by Tektronix;

 

•                      variationsin our results of operations;

 

•                      changes inour business strategy;

 

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•                      future salesof our common stock, particularly by institutional investors with largeholdings and by our founders;

 

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

 

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

 

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

 

•                      generalmarket and economic conditions; and

 

•                      equitymarket conditions and industry-specific equity market trends.

 

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

 

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

 

**Item 3.****           Quantitativeand Qualitative Disclosures about Market Risk**

 

Historically, we havebeen exposed to immaterial levels of market risk and have not beensignificantly exposed to fluctuations in currency exchange rates. In the sixmonths ended June 30, 2004, approximately 3% of total revenues was denominatedin currencies other than the U.S. dollar. In the full-year 2003, approximately 3% of total revenues wasdenominated in currencies other than the U.S. dollar, principally theEuro.  In future periods, we believe agreater portion of total revenues could be denominated in currencies other thanthe U.S. dollar, thereby increasing our exposure to exchange rate gains andlosses on non-U.S. currency transactions. Currently, we do not engage in hedging activities for our non-U.S.dollar business.

 

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

 

Ourinternational business is subject to the typical risks of any internationalbusiness, including, but not limited to, the risks described in Item 2 –“Management’s Discussion and Analysis of Financial Condition and Results ofOperations – Risk Factors.”  Accordingly,our future results could be materially harmed by the actual occurrence of anyof these or other risks.

 

Currently,our cash is invested in bank deposits and money market funds denominated in U.S. dollars. We account for theseinvestments in accordance with SFAS 115, *Accounting for CertainInvestments in Debt and Equity Securities*. These cash equivalentsare treated as available-for-sale under SFAS 115.  The carrying value of these cash equivalentsapproximates fair market value.  We alsoinvest in U.S. Treasury bills, U.S. government agency discount notes andcommercial paper.  U.S. Treasury

 

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bills, U.S. government agencydiscount notes and commercial paper with maturities that are less than 90 daysare classified as cash equivalents.  U.STreasury bills, U.S. government agency discount notes and commercial paper withmaturities that are more than 90 days but less than one year are classified asshort-term investments.  All U.S.Treasury bills, U.S. government agency discount notes and commercial paper areclassified as held to maturity and carried at amortized cost.  Our investments are subject to interest raterisk, which is the risk that our financial condition and results of operationscould be adversely affected due to movements in interest rates.  Assuming current levels of cash, if the perannum rate of interest earned on our invested cash were to change by 50 basispoints, or 0.5%, our investment income would be impacted by approximately $0.4million on an annual basis.

 

**Item 4.****           Controlsand Procedures**

 

(a)               Evaluation ofdisclosure controls and procedures. We maintain disclosure controls andprocedures designed to provide reasonable assurance that information requiredto be disclosed in the periodic reports we file with the SEC is recorded,processed, summarized and reported within the time periods specified in therules of the SEC.  We carried out anevaluation as of June 30, 2004, under the supervision and the participation ofour management, including our chief executive officer and chief financialofficer, of the design and operation of these disclosure controls andprocedures pursuant to Exchange Act Rule 13a-15(e).  Based upon that evaluation, our chiefexecutive officer and chief financial officer concluded that our disclosurecontrols and procedures are effective in timely alerting them to materialinformation relating to the company (including our consolidated subsidiaries)required to be included in our periodic SEC filings.

 

(b)              Changes ininternal control over financial reporting. There was no change in ourinternal control over financial reporting that occurred during the three monthsended June 30, 2004 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**PART II****.****                    OTHERINFORMATION**

 

**Item 2.****           Changes inSecurities, Use of Proceeds and Issuer Purchases ofEquity Securities**

 

The Securities and Exchange Commission on May 26, 1999declared 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, 2004, we have used all of thenet offering proceeds for the purchase of temporary investments, consisting ofcash, cash equivalents, and short-term investments.  We currently intend to use the net proceedsof the offering for working capital and general corporate purposes, includingfinancing accounts receivable and capital expenditures made in the ordinarycourse of business.  We also may apply aportion of the proceeds of the offering to acquire businesses, products andtechnologies, or enter into joint venture arrangements, that are complementaryto our business and product offerings; however, at this time we have notidentified a specific acquisition or joint venture or allocated a specificamount for this purpose. We also may applya portion of the proceeds to the payment of cash dividends or for additionalstock repurchases or other similar transactions.

 

During the three monthsended June 30, 2004, we repurchased 1,458 shares of our common stock inconnection with our obligation to a holder of restricted stock to withhold thenumber of shares required to satisfy such holder’s tax liability in connectionwith the vesting of such shares.  Thefollowing table sets forth certain specifics of the repurchase:

 
| **Period**               | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price Paid  per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number  (or Approximate  Dollar Value) of  Shares that May Yet  Be Purchased Under  the Plans or  Programs** | ** ** |
|--------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|
| **April  1 to April 30** |       | —                                |       | —                            |       | N/A                                                                                      |       | N/A                                                                                                                    |       |
| **May  1 to May 31**     |       | 1,458                                 |       | $                                 | 10.42      |                                                                                     | N/A        |                                                                                                                   | N/A        |   |
| **June  1 to June 30**   |       | —                                |       | —                            |       | N/A                                                                                      |       | N/A                                                                                                                    |       |
| **Total**                |       | 1,458                                 |       | $                                 | 10.42      |                                                                                     | **N/A**    | ** **                                                                                                             | **N/A**    |   |

 

**Item 4.****           Submission of Matters to a Vote ofSecurity Holders**

 

At our 2004 Annual Meeting of Stockholders held on May11, 2004, our stockholders voted on and approved the following matters:

 

1.  The electionof two Class I directors to serve until our 2007 Annual Meeting ofStockholders, or until their successors have been elected and qualified.

 
| **Name  of Nominee** | ** ** | **Number of Votes For** | ** ** | **Number of Votes Withheld** | ** ** |
|----------------------|------------|-------------------------|------------|------------------------------|------------|
|                 |       |                    |       |                         |       |
| James R. Adams       |       | 34,832,279              |       | 678,425                      |       |
| M. Samuel Self       |       | 34,890,179              |       | 620,525                      |       |

 

2.  Ratificationof the amendment to our 1998 Employee Stock Purchase Plan.

 

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| **Number  of Votes For** | ** ** | **Number of Votes Against** | ** ** | **Number of Votes Abstained** | ** ** |
|--------------------------|------------|-----------------------------|------------|-------------------------------|------------|
|                     |       |                        |       |                          |       |
| 29,345,010               |       | 1,977,902                   |       | 68,340                        |       |

 

3.  Ratificationof the selection of Ernst & Young LLP as our independent auditors for 2004.

 
| **Number  of Votes For** | ** ** | **Number of Votes Against** | ** ** | **Number of Votes Abstained** | ** ** |
|--------------------------|------------|-----------------------------|------------|-------------------------------|------------|
|                     |       |                        |       |                          |       |
| 34,976,479               |       | 532,116                     |       | 2,109                         |       |

 

**Item 6.****           Exhibitsand Reports on Form 8-K**

 

(a)               Exhibits

 
| 2.1  |   | Agreement and Plan of Merger, dated as of June 29,  2004, among Tektronix, Inc., Inet Technologies, Inc., Inet Merger Corp. and  Inet Acquisition Co. LLC (previously filed as an exhibit to the registrant’s  Form 8-K filed on June 30, 2004 and incorporated herein by reference). |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1 |   | Inet Technologies, Inc. 1998  Employee Stock Purchase Plan (previously filed as an exhibit to the  registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2002 and incorporated herein by reference).                                                             |
| 10.2 |   | First Amendment to the Inet Technologies, Inc. 1998  Employee Stock Purchase Plan (previously filed as an exhibit to the  registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001  and incorporated herein by reference).                                      |
| 10.3 |   | Second Amendment to the Inet Technologies, Inc. 1998  Employee Stock Purchase Plan (previously filed as an exhibit to the  registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2002 and incorporated herein by reference).                                     |
| 10.4 |   | Third Amendment to the Inet Technologies, Inc. 1998  Employee Stock Purchase Plan (previously filed as an exhibit to the  registrant’s Registration Statement on Form S-8 (File No. 333-117469) and  incorporated herein by reference).                                               |
| 10.5 |   | Inet Technologies, Inc. 1998 Employee Stock Purchase  Plan, as amended and restated effective August 1, 2004 (previously filed as  an exhibit to the registrant’s Registration Statement on Form S-8 (File No.  333-117469) and incorporated herein by reference).                    |
| 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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(b)              Reports on Form 8-K

 

During the three months ended June 30, 2004 we filedor furnished two Reports on Form 8-K. Information regarding each item reported on is listed below.

 
| **Date  Filed or  Furnished** | ** ** | **Item No.**  | ** ** | **Description**                                                                                                                         | ** ** |
|-------------------------------|------------|---------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 20, 2004                |       | Item 12       |       | On April 20, we announced our results of operations  for the three months ended March 31, 2004.*                                        |       |
| June 30, 2004                 |       | Items 5 and 7 |       | On June 29, we announced our Agreement and Plan of  Merger with Tektronix, Inc., which provides for our acquisition by Tektronix,  Inc. |       |

 

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* This furnished Form 8-K is not to be deemed filed orincorporated by reference into any filing.

 

**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 theundersigned thereunto duly authorized.

 
|                                                    | INET TECHNOLOGIES, INC. |
|---------------------------------------------------------|-------------------------|
|                                                    |                    |
|                                                    | By:                     | /s/ Jeffrey A. Kupp |   |
|                                                    |                    | Jeffrey A. Kupp |
|                                                    |                    | Vice President and Chief Financial Officer  (Principal accounting and financial officer) |
|                                                    |                    |
| Date:      July 21,  2004 |                    |
|                                                         |                         |  |  |  |

 

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**INET TECHNOLOGIES, INC.**

**INDEX TO EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description** |
|---------------------|------------|-----------------|
| 2.1                 |       |            | Agreement and Plan of Merger, dated as of June 29,  2004, among Tektronix, Inc., Inet Technologies, Inc., Inet Merger Corp. and  Inet Acquisition Co. LLC (previously filed as an exhibit to the registrant’s  Form 8-K filed on June 30, 2004 and incorporated herein by reference). |
| 10.1                |       |            | Inet Technologies, Inc. 1998 Employee  Stock Purchase Plan (previously filed as an exhibit to the  registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2002 and incorporated herein by reference). |
| 10.2                |       |            | First Amendment to the Inet Technologies, Inc. 1998  Employee Stock Purchase Plan (previously filed as an exhibit to the  registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2001 and incorporated herein by reference). |
| 10.3                |       |            | Second Amendment to the Inet Technologies, Inc. 1998  Employee Stock Purchase Plan (previously filed as an exhibit to the  registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2002 and incorporated herein by reference). |
| 10.4                |       |            | Third Amendment to the Inet Technologies, Inc. 1998  Employee Stock Purchase Plan (previously filed as an exhibit to the  registrant’s Registration Statement on Form S-8 (File No. 333-117469) and  incorporated herein by reference). |
| 10.5                |       |            | Inet Technologies, Inc. 1998 Employee Stock Purchase  Plan, as amended and restated effective August 1, 2004 (previously filed as  an exhibit to the registrant’s Registration Statement on Form S-8 (File No.  333-117469) and incorporated herein by reference). |
| 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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