~~Table~~SECURITIES AND ofEXCHANGE ~~Contents~~COMMISSION

~~SECURITIES AND EXCHANGE COMMISSION~~ Washington, D.C. 20549

~~Washington,~~FORM ~~D.C. 20549~~ 10-Q

~~FORM~~ý QUARTERLY ~~10-Q~~REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.

xFor ~~QUARTERLY~~the ~~REPORT~~quarterly ~~PURSUANT~~period TOended ~~SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.~~March 31, 2004

~~For the quarterly period ended September 30, 2003~~OR

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

¨Commission ~~TRANSITION~~File ~~REPORT~~Number ~~PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.~~0-24707

~~Commission~~INET ~~File~~TECHNOLOGIES, ~~Number 0-24707~~ INC.

~~INET~~(Exact ~~TECHNOLOGIES,~~name ~~INC.~~of registrant as specified in its charter)

(Exact name of registrant as specified in its charter)

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

1500 North Greenville Avenue Richardson, Texas 75081
(Address of principal executive offices, including zip code)

(469) 330-4000
(Registrant’s telephone number, including area code)

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

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

~~1500~~Indicate ~~North~~by check mark whether the registrant is an accelerated filer ~~Greenville~~(as ~~Avenue~~defined in Exchange Act Rule 12b-2). Yes ý No o

~~Richardson,~~Number ~~Texas~~of ~~75081~~shares of common stock outstanding at April 20, 2004: 39,220,388

~~(Address of principal executive offices~~Inet Technologies, ~~including zip code)~~ Inc.

~~(469) 330-4000~~ Index

(Registrant’s telephone number, including area code)

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 6.	Exhibits and Reports on Form 8-K

Signatures

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

~~Indicate~~PART ~~by check mark whether the registrant is an “accelerated filer” (as defined in Exchange Act Rule 12b-2)~~I. ~~Yes x No ¨~~ FINANCIAL INFORMATION

~~Number~~Item ~~of shares of common stock outstanding at October~~1. Financial ~~17, 2003: 38,725,161~~ Statements

~~Table~~INET ofTECHNOLOGIES, ~~Contents~~INC.

~~Inet~~CONDENSED ~~Technologies,~~CONSOLIDATED ~~Inc.~~BALANCE SHEETS

~~Index~~ (Unaudited)

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

(In thousands, except share data)

Page 2 of 35

	March 31, 2004			December 31, 2003
ASSETS

Current assets:
Cash and cash equivalents	$	72,898		$	118,527
Short-term investments	99,267			55,034
Trade accounts receivable, net of allowance for doubtful accounts of $514 at March 31, 2004 and December 31, 2003	15,066			10,870
Unbilled receivables	236			146
Inventories	8,957			7,924
Deferred income taxes	1,829			1,628
Other current assets	6,007			5,055
Total current assets	204,260			199,184
Property and equipment, net	10,741			11,330
Deferred income taxes	201			217
Other assets	614			613
Total assets	$	215,816		$	211,344

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	2,037		$	1,919
Income taxes payable	3,181			2,408
Accrued compensation and benefits	2,593			4,115
Deferred revenues	20,977			21,554
Other accrued liabilities	4,365			3,724
Total current liabilities	33,153			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 March 31, 2004 and December 31, 2003	47			47
Additional paid-in capital	78,191			77,866
Unearned compensation	(2,423		)	(2,610		)
Retained earnings	138,208			134,932
Treasury stock, 7,939,255 common shares at March 31, 2004 and 8,240,060 common shares at December 31, 2003, at cost	(31,360		)	(32,611		)
Total stockholders’ equity	182,663			177,624
Total liabilities and stockholders’ equity	$	215,816		$	211,344

~~Table~~See ofaccompanying ~~Contents~~notes to our condensed consolidated financial statements.

~~PART I. FINANCIAL INFORMATION~~ 3

~~Item~~INET 1.TECHNOLOGIES, ~~Financial Statements~~ INC.

~~INET~~CONDENSED ~~TECHNOLOGIES,~~CONSOLIDATED ~~INC.~~STATEMENTS OF INCOME

~~CONSOLIDATED BALANCE SHEETS~~ (Unaudited)

(~~Unaudited)~~In thousands, except per share data)

(In thousands, except share data)

	Three months ended March 31,
	2004			2003

Revenues:
Product and license fees	$	19,647		$	17,518
Services	7,565			7,524
Total revenues	27,212			25,042

Cost of revenues:
Product and license fees	5,227			2,902
Services	3,188			4,167
Total cost of revenues	8,415			7,069

Gross profit	18,797			17,973
Operating expenses:
Research and development	8,126			7,685
Sales and marketing	4,307			3,515
General and administrative	2,261			2,419
	14,694			13,619
Income from operations	4,103			4,354
Other income (expense):
Interest income	369			426
Other income (expense)	(155		)	16
	214			442
Income before provision for income taxes	4,317			4,796
Provision for income taxes	1,041			1,541
Net income	$	3,276		$	3,255

Earnings per common share:
Basic	$	0.08		$	0.08
Diluted	$	0.08		$	0.08

Weighted-average shares outstanding:
Basic	39,119			40,395
Diluted	39,788			40,563

	September 30, 2003			December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	168,742		$	189,076
Trade accounts receivable, net of allowance for doubtful accounts of $508 at September 30, 2003 and $484 at December 31, 2002		7,487			10,211
Unbilled receivables		33			155
Inventories		6,615			7,458
Deferred income taxes		907			850
Other current assets		6,999			4,909
Total current assets		190,783			212,659
Property and equipment, net		12,353			15,215
Other assets		586			300
Total assets	$	203,722		$	228,174
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,761		$	1,078
Accrued compensation and benefits		2,651			4,113
Deferred revenues		19,496			18,323
Income taxes payable		508			1,953
Other accrued liabilities		5,190			4,733
Total current liabilities		29,606			30,200
Deferred income taxes		149			18
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $.001 par value:
Authorized shares—25,000,000 Issued shares—None		—			—
Common stock, $.001 par value:
Authorized shares—175,000,000 Issued shares—47,159,643 at September 30, 2003 and 47,157,543 at December 31, 2002		47			47
Additional paid-in capital		76,012			75,075
Unearned compensation		(310	)		(407	)
Retained earnings		131,545			123,241
Treasury stock, 8,437,308 common shares at September 30, 2003 and no common shares at December 31, 2002, at cost		(33,327	)		—
Total stockholders’ equity		173,967			197,956
Total liabilities and stockholders’ equity	$	203,722		$	228,174

See accompanying notes to our condensed consolidated financial statements.

~~See accompanying notes to consolidated financial statements.~~ 4

~~Page~~INET 3TECHNOLOGIES, ~~of 35~~ INC.

~~Table~~CONDENSED ofCONSOLIDATED ~~Contents~~STATEMENT OF STOCKHOLDERS’ EQUITY

~~INET TECHNOLOGIES, INC.~~ (Unaudited)

~~CONSOLIDATED~~(In ~~STATEMENTS~~thousands, OFexcept ~~INCOME~~share data)

(Unaudited)

				Additional Paid-in Capital		Unearned Compensation			Retained Earnings							Total Stockholders’ Equity
	Common Stock										Treasury Stock
	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
Issuance of common stock under employee stock option and stock purchase plans, including tax benefit of $240	—	—		325		—			—		(300,805	)	1,251			1,576
Net income	—	—		—		—			3,276		—		—			3,276
Amortization of restricted stock awards	—	—		—		187			—		—		—			187
Balance at March 31, 2004	47,159,643	$	47	$	78,191	$	(2,423	)	$	138,208	7,939,255		$	(31,360	)	$	182,663

~~(In~~See ~~thousands,~~accompanying ~~except~~notes ~~per~~to ~~share~~our ~~data)~~condensed consolidated financial statements.

	Three months ended September 30,						Nine months ended September 30,
	2003			2002			2003			2002
Revenues:
Product and license fees	$	18,072		$	16,569		$	53,360		$	56,805
Services		7,962			6,587			23,188			20,066
Total revenues		26,034			23,156			76,548			76,871
Cost of revenues:
Product and license fees		4,717			6,975			13,955			21,178
Services		3,743			3,008			11,213			9,473
Total cost of revenues		8,460			9,983			25,168			30,651
Gross profit		17,574			13,173			51,380			46,220
Operating expenses:
Research and development		7,412			7,026			22,354			22,776
Sales and marketing		3,889			3,642			11,012			12,506
General and administrative		2,456			1,829			6,936			5,967
Restructuring costs		—			224			—			224
		13,757			12,721			40,302			41,473
Income from operations		3,817			452			11,078			4,747
Other income (expense):
Interest income		290			654			1,088			2,009
Other income (expense)		(140	)		(31	)		(249	)		203
		150			623			839			2,212
Income before provision for income taxes		3,967			1,075			11,917			6,959
Provision for income taxes		1,189			269			3,613			2,088
Net income	$	2,778		$	806		$	8,304		$	4,871
Earnings per common share:
Basic	$	0.07		$	0.02		$	0.21		$	0.10
Diluted	$	0.07		$	0.02		$	0.21		$	0.10
Weighted-average shares outstanding:
Basic		38,612			47,011			39,129			46,913
Diluted		39,238			47,043			39,461			47,018

~~See~~INET ~~accompanying~~TECHNOLOGIES, ~~notes to consolidated financial statements~~INC.

~~Page~~CONDENSED 4CONSOLIDATED ofSTATEMENTS 35OF CASH FLOWS

~~Table of Contents~~(Unaudited)

~~INET~~(In ~~TECHNOLOGIES, INC.~~ thousands)

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

	Three months ended March 31,
	2004			2003

Cash flows from operating activities:
Net income	$	3,276		$	3,255
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	1,449			1,803
Amortization of purchase discounts on investments	(205		)	—
Stock compensation	187			141
Deferred income taxes	(185		)	—
Changes in operating assets and liabilities:
Increase in trade accounts receivable	(4,196		)	(1,527		)
Increase in unbilled receivables	(90		)	(25		)
Increase in inventories	(1,033		)	(967		)
Increase in other assets	(953		)	(217		)
Increase in accounts payable	118			395
Increase in taxes payable	1,013			1,316
Decrease in accrued compensation and benefits	(1,522		)	(1,302		)
Increase (decrease) in deferred revenues	(577		)	5,688
Increase in other accrued liabilities	641			1,250
Net cash provided by (used in) operating activities	(2,077		)	9,810

Cash flows from investing activities:
Purchases of short-term investments	(44,028		)	—
Purchases of property and equipment	(860		)	(932		)
Net cash used in investing activities	(44,888		)	(932		)

Cash flows from financing activities:
Repurchase of common stock	—			(35,431		)
Proceeds from issuance of common stock upon exercise of stock options and purchases under employee stock purchase plan	1,336			616
Net cash provided by (used in) financing activities	1,336			(34,815		)

Net decrease in cash and cash equivalents	(45,629		)	(25,937		)
Cash and cash equivalents at beginning of period	118,527			189,076
Cash and cash equivalents at end of period	$	72,898		$	163,139

Supplemental disclosure:
Income taxes paid	$	48		$	155

~~(Unaudited)~~See accompanying notes to our condensed consolidated financial statements.

~~(In thousands, except share data)~~ 6

	Common Stock			AdditionalPaid-inCapital		UnearnedCompensation			RetainedEarnings		Treasury Stock					TotalStockholders’Equity
	Shares	Amount									Shares		Amount
Balance at December 31, 2002	47,157,543	$	47	$	75,075	$	(407	)	$	123,241	—		$	—		$	197,956
Repurchase of common stock	—		—		—		—			—	8,993,984			(35,553	)		(35,553	)
Issuance of common stock under employee stock option and stock purchase plans, including tax benefit of $483	2,100		—		937		(109	)		—	(556,676	)		2,226			3,054
Net income	—		—		—		—			8,304	—			—			8,304
Amortization of restricted stock awards	—		—		—		206			—	—			—			206
Balance at September 30, 2003	47,159,643	$	47	$	76,012	$	(310	)	$	131,545	8,437,308		$	(33,327	)	$	173,967

INET TECHNOLOGIES, INC.

~~See~~NOTES ~~accompanying~~TO ~~notes~~CONDENSED CONSOLIDATED toFINANCIAL ~~consolidated financial statements.~~ STATEMENTS

~~Page 5 of 35~~ (Unaudited)

~~Table~~Note 1 - Summary of Significant ~~Contents~~Accounting Policies

~~INET~~The ~~TECHNOLOGIES, INC.~~ Company

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

~~(Unaudited)~~ Consolidation

~~(In~~The condensed ~~thousands)~~consolidated financial statements include the accounts of our wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated.

	Nine months ended September 30,
	2003			2002
Cash flows from operating activities:
Net income	$	8,304		$	4,871
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		5,282			5,329
Stock compensation		206			—
Deferred income taxes		74			638
Changes in operating assets and liabilities:
Decrease in trade accounts receivable		2,724			922
Decrease in unbilled receivables		122			1,561
Decrease in income taxes receivable		—			701
Decrease in inventories		843			4,838
Increase in other assets		(2,376	)		(239	)
Increase in accounts payable		683			1,520
Decrease in taxes payable		(962	)		—
Increase (decrease) in accrued compensation and benefits		(1,462	)		606
Increase (decrease) in deferred revenues		1,173			(5,402	)
Increase in other accrued liabilities		957			1,428
Net cash provided by operating activities		15,568			16,773
Cash flows from investing activities:
Purchases of property and equipment		(2,920	)		(1,554	)
Net cash used in investing activities		(2,920	)		(1,554	)
Cash flows from financing activities:
Repurchase of common stock		(35,553	)		—
Proceeds from issuance of common stock upon exercise of stock options and purchases under employee stock purchase plan		2,571			1,603
Net cash provided by (used in) financing activities		(32,982	)		1,603
Net (decrease) increase in cash and cash equivalents		(20,334	)		16,822
Cash and cash equivalents at beginning of period		189,076			154,889
Cash and cash equivalents at end of period	$	168,742		$	171,711
Supplemental disclosure:
Income taxes paid	$	2,542		$	1,833

Unaudited Interim Financial Statements

~~See~~We have prepared the accompanying ~~notes~~unaudited condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and the instructions to ~~consolidated~~Form 10-Q and Article 10 of Regulation S-X. Accordingly, these statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In our opinion, all adjustments (consisting solely of normal recurring adjustments) necessary for a fair statement of the results for the interim periods presented have been included. These financial statements should be read in conjunction with the audited financial statements and related notes for the three years ended December 31, 2003 included in our Form 10-K filed with the Securities and Exchange Commission, or SEC, on January 30, 2004. Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2004.

~~Page~~Accounting ~~6 of 35~~ Estimates

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

~~INET~~Basis ~~TECHNOLOGIES,~~of ~~INC.~~ Presentation

~~NOTES~~Certain TOprior ~~CONSOLIDATED~~period ~~FINANCIAL~~amounts ~~STATEMENTS~~have been reclassified to conform to the current period presentation.

~~(Unaudited)~~Cash and Cash Equivalents

~~Note~~Cash ~~1—Summary~~and cash equivalents consist of ~~Significant~~bank ~~Accounting~~deposits, ~~Policies~~money-market funds and commercial paper. All highly-liquid securities with original maturities of three months or less are classified as cash equivalents.

~~The Company~~ 7

~~Inet~~The ~~Technologies,~~carrying ~~Inc.~~value ~~is a global provider~~ of ~~communications~~our ~~software~~bank ~~products~~deposits ~~that enable communications carriers to more strategically~~ and ~~profitably~~money-market ~~operate~~funds approximates ~~their~~fair ~~businesses.~~market value. Our ~~Unified Assurance Solution and our Diagnostics products~~ ~~help~~commercial ~~our~~paper ~~customers~~is ~~reduce~~classified ~~capital~~as ~~and~~held ~~operating~~to ~~expenditures,~~maturity ~~improve customer acquisition~~ and ~~retention~~carried ~~rates,~~at ~~protect and grow revenues, and more quickly and effectively develop products or services. Our products address next-generation networks,~~amortized ~~including mobile data and voice-over-packet technologies, and traditional networks~~cost.

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

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

~~The~~At ~~consolidated~~March 31, ~~financial~~2004, ~~statements include the accounts of~~ our ~~wholly~~short-~~owned~~term investments ~~subsidiaries.~~were ~~Intercompany~~as ~~balances~~follows ~~and~~(in ~~transactions have been eliminated.~~ thousands):

Unaudited Interim Financial Statements

	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
U.S. Treasury bills	$	75,242	$	3	$	—	$	75,245
U.S. government agency discount notes	24,025		—		2		24,023
Total short-term investments	$	99,267	$	3	$	2	$	99,268

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

Page 7 of 35

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

~~Table~~Allowance for ofDoubtful ~~Contents~~Accounts

~~Accounting~~A ~~Estimates~~large portion of our revenues and accounts receivable are attributable to our carrier customers in the communications industry and, to a lesser extent, to our equipment manufacturer customers who supply equipment into the communications industry. Our trade accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our customers. Because our accounts receivable are usually unsecured, we periodically evaluate the collectibility of our accounts based on a combination of factors, including a particular customer’s ability to pay and the age of the receivables. To evaluate a specific customer’s ability to pay, we analyze the customer’s payment history, if any, financial statements or other information provided by the customer, or third-party credit analysis reports or other publicly-available information. In cases where the evidence suggests a customer may not be able to satisfy its obligations to us, we set up a specific reserve in an amount we determine appropriate for the perceived risk. Most of our contracts include multiple payment milestones, some of which occur in advance of revenue recognition, which mitigates our risk both in terms of collectibility and adjustments to recorded revenue. We have not historically experienced significant losses on uncollectible accounts and our allowance has been less than 5% of recorded receivables.

The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. As discussed below, we make significant estimates and assumptions in the areas of accounts receivable, inventories, revenue recognition and taxes. Although we believe that our estimates and assumptions are reasonable, actual results may differ, and such differences could be significant to our financial results. 8

~~Basis of Presentation~~ Inventories

~~Certain~~Inventories ~~prior~~are ~~period~~valued ~~amounts~~at ~~have~~the ~~been~~lower ~~reclassified~~of standard tocost, ~~conform~~which toapproximates ~~the~~actual ~~current~~cost ~~period~~determined ~~presentation~~on a first-in, first-out basis, or market. At March 31, 2004 and December 31, 2003, inventories consisted of the following (in thousands):

Cash and Cash Equivalents

	March 31, 2004		December 31, 2003

Raw materials	$	3,430	$	3,498
Work-in-process	128		219
Finished goods	5,399		4,207
	$	8,957	$	7,924

~~Cash~~Inventories ~~and~~are recorded ~~cash~~net ~~equivalents~~of ~~consist~~allowances offor ~~bank~~unsalable ~~deposits~~or ~~and~~obsolete ~~money~~raw materials, work-~~market~~in-process ~~funds~~and finished goods. We ~~All~~evaluate ~~highly-liquid~~on ~~securities~~a ~~with~~quarterly ~~original~~basis ~~maturities~~the status of ~~three~~our ~~months~~inventory to ensure the amount recorded in our financial statements reflects the lower of our cost or ~~less~~the value ~~are~~we ~~classified~~expect asto ~~cash~~receive ~~equivalents~~when we sell the inventory. This ~~The~~estimate ~~carrying~~is ~~value~~based on several factors, including the condition and salability of ~~cash~~our ~~equivalents~~inventory ~~approximates~~and ~~fair~~the ~~market~~forecasted demand ~~value~~for the particular products incorporating inventory components. Based on current backlog, expected orders and other expected demand, we forecast the usage of current stock. We record reserves for obsolete and slow-moving parts of up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk.

~~Allowance~~Revenue ~~for Doubtful Accounts~~ Recognition

AWe ~~large~~derive ~~portion~~revenues ofprimarily ~~our~~from ~~revenues~~product and license ~~accounts~~fees ~~receivable~~as ~~are~~well ~~attributable~~as ~~to our carrier customers in the communications industry and~~services, towhich ainclude ~~lesser extent~~training, towarranty ~~our~~and ~~equipment~~product support ~~manufacturer~~services. ~~customers~~The ~~who~~majority ~~supply~~of ~~equipment into~~ the ~~communications~~contracts ~~industry.~~for ~~Our~~our ~~trade~~Unified ~~accounts~~Assurance products ~~receivable~~contain ~~balance~~multiple isbilling ~~recorded~~milestones, ~~net~~such ofas ~~allowances~~contract ~~for~~award, ~~amounts not expected to be collected from our~~shipment, ~~customers.~~installation, ~~Because~~ready ~~our~~for ~~accounts~~acceptance ~~receivable~~and ~~are usually unsecured~~acceptance, wenot ~~periodically~~all ~~evaluate~~of ~~the~~which ~~collectibility~~are ofassociated with ~~our~~revenue ~~accounts~~recognition. ~~based~~Except onas aotherwise ~~combination~~discussed ~~of factors~~below, ~~including~~revenues afrom product ~~particular~~and ~~customer’s~~license ~~ability~~fees toare ~~pay~~recognized ~~and~~in the ~~age~~period ofthat ~~the~~we ~~receivables.~~have Tocompleted ~~evaluate~~all ahardware ~~specific~~manufacturing ~~customer’s~~and/or ~~ability~~software development to ~~pay~~contractual specifications, wefactory ~~analyze~~testing ~~the~~has ~~customer’s~~been ~~payment history~~completed, ifthe ~~any,~~product ~~financial~~has ~~statements~~been shipped orto ~~other information provided by~~ the customer, orthe ~~third-party~~fee ~~credit~~is ~~analysis~~fixed ~~reports~~and ordeterminable ~~other~~and ~~publicly-available information.~~collection ~~In cases where~~ of the ~~evidence~~fee ~~suggests~~is aconsidered ~~customer~~probable. When ~~may~~we have ~~not~~significant beobligations ~~able~~subsequent to ~~satisfy its obligations to us~~shipment, wesuch ~~set~~as upinstallation aand system ~~specific~~integration, ~~reserve~~revenues inare anrecognized ~~amount~~when wethere ~~determine~~are ~~appropriate~~no ~~for~~significant unfulfilled ~~the perceived risk~~obligations. Revenues ~~Most~~from arrangements ofthat ~~our contracts~~ include ~~multiple~~significant ~~payment milestones,~~acceptance ~~some of which occur in advance of revenue recognition, which mitigates our risk both in~~ terms ofand/or ~~collectibility~~provisions and revenues ~~adjustments~~from toarrangements ~~recorded revenue. Given~~ that ~~most~~include ofsignificant ~~our~~developmental ~~customers~~items are recognized ~~large~~when ~~public~~acceptance ~~companies~~has ~~with substantial resources,~~occurred. weRevenues ~~have~~from ~~not~~our ~~historically~~Diagnostics ~~experienced~~products ~~significant~~are ~~losses~~typically onrecognized ~~uncollectible~~when title ~~accounts~~ and ~~our~~risk ~~allowance has been less than 5%~~ of ~~recorded~~loss ~~receivables.~~pass Ifto the ~~current~~customer, ~~downturn~~which intypically ~~the~~occurs ~~communications~~at shipment. For ~~industry~~these ~~continues~~products, ~~the financial condition of our~~we ~~customers~~typically ~~could~~have ~~deteriorate~~no ~~and~~significant ~~they~~obligations ~~may~~subsequent ~~not be able~~ to ~~meet their financial obligations to us~~shipment. If ~~this~~a significant obligation were to ~~occur~~exist, we ~~the~~would ~~net~~defer ~~value~~revenue ~~realized~~recognition ~~from~~until ~~our~~such ~~receivables~~obligation ~~may~~was besatisfied. All ~~materially~~shipping ~~different~~costs ~~from~~are ~~the~~included ~~net~~in ~~balance~~cost ~~recorded~~of revenues onin our ~~balance~~condensed ~~sheet~~consolidated statements of income.

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

Inventories are valued at the lower of standard cost, which approximates actual cost determined on a first-in, first-out basis, or market. At September 30, 2003 and December 31, 2002, inventories consisted of the following (in thousands): 9

~~Page~~contract 8amount based on the fair value of 35these services determined using VSOE. Revenues from other services, such as training, are recognized when the services have been completed. If we determine that we do not have VSOE on an undelivered element of an arrangement, we will not recognize revenue until all elements of the arrangement are delivered.

~~Table~~Deferred ofrevenues ~~Contents~~represent amounts billed to customers, but not yet recognized as revenue. Unbilled receivables represent amounts recognized as revenue, but not yet billed to customers.

	September 30, 2003		December 31, 2002
Raw materials	$	2,856	$	3,774
Work-in-process		90		445
Finished goods		3,669		3,239
	$	6,615	$	7,458

Income Taxes

~~Inventories~~Our ~~are recorded~~income ~~net~~taxes ofare ~~allowances~~computed ~~for~~using ~~unsalable~~the ~~or obsolete raw materials, work-in-process~~ asset and ~~finished~~liability ~~goods.~~method ~~We evaluate on a quarterly basis the status~~ of ~~our inventory to ensure the amount recorded in our financial statements reflects the lower of our~~accounting. ~~cost~~Under or the ~~value~~asset weand ~~expect~~liability ~~to receive when we sell the inventory. This estimate is based on several factors~~method, ~~including~~a ~~the~~deferred ~~condition~~tax ~~and~~asset ~~salability~~or ~~of our inventory and the forecasted demand for the particular products incorporating these~~liability ~~components.~~is ~~Based~~recognized ~~on current backlog and expected orders, we forecast the upcoming usage of current stock. We record reserves~~ for ~~obsolete~~estimated ~~and~~future ~~slow-moving~~tax ~~parts~~effects ofattributable up to ~~100% for excess parts with insufficient demand or obsolete parts. Amounts in~~temporary ~~work-in-process~~differences and ~~finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk~~carryforwards.

~~Revenue~~In ~~Recognition~~the preparation of our provision for income taxes, there may be many transactions and calculations where the ultimate tax outcome is uncertain. The calculation of tax liabilities and the determination of whether deferred tax assets will be realized in full or in part involves dealing with uncertainties in the application of complex and potentially changing tax laws. Therefore, we must estimate several factors. For example, when it is more likely than not that all or some portion of a deferred tax asset will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable. As of March 31, 2004 and December 31, 2003, a valuation for deferred tax assets was not deemed necessary. If the facts underlying our determination or our financial results were to change in a manner impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of valuation allowance required in any given period. Additionally, because our income tax returns are subject to review and examination in the various jurisdictions in which we operate, the Company recognizes potential liabilities for anticipated tax issues and adjusts those potential liabilities based on an estimate of the ultimate resolution of whether, and the extent to which, additional taxes will be due. We are currently not aware of any material issues that have been raised by taxing jurisdictions, and management believes that all income tax issues that may be raised as a result of such reviews and examinations in the future will be resolved with no material impact on our financial condition or results of operations. However, in the event there was an assessment by any of these jurisdictions, it could impact our tax provision.

WeOur ~~derive~~annual ~~revenues~~effective ~~primarily~~tax ~~from~~rate ~~product~~is ~~and~~currently expected ~~license~~to ~~fees~~be ~~as well as services, which include training, warranty and product support services~~29.5% ~~The majority~~for of the ~~contracts~~year ~~for~~ending ~~our~~December ~~GeoProbe~~31, ~~Orion and Beamer products contain multiple billing milestones, such as contract award, shipment, installation and acceptance, not all of which are associated with revenue recognition~~2004. This ~~Except~~tax asrate ~~otherwise discussed~~differs ~~below, revenues~~ from ~~product and license fees are recognized in~~ the ~~period~~35% ~~that~~statutory corporate wetax ~~have~~rate ~~completed~~primarily ~~all~~due ~~hardware manufacturing and/or software development~~ to ~~contractual~~the ~~specifications,~~effect ~~factory~~of ~~testing has been completed,~~ the ~~product~~extraterritorial ~~has~~income ~~been~~exclusion ~~shipped to the customer, the fee is fixed~~ and ~~determinable~~research and ~~collection~~development oftax ~~the fee is considered probable~~credits. This ~~When~~tax werate ~~have~~currently ~~significant~~reflects ~~obligations~~the ~~subsequent~~impact toof ~~shipment,~~research ~~such as installation~~ and ~~system integration, revenues are recognized when~~ ~~there~~development ~~are~~tax nocredits ~~significant~~through ~~unfulfilled~~June ~~obligations.~~2004 ~~Revenues~~at ~~from~~which ~~arrangements~~time ~~that~~the ~~include significant acceptance terms and/or provisions are recognized when acceptance has occurred~~statute expires. As ~~Revenues~~such, ~~from~~ our ~~Diagnostics~~effective ~~products are typically recognized~~tax ~~when~~rate ~~title~~could ~~and~~be ~~risk~~impacted ofif ~~loss pass to~~ the ~~customer,~~research ~~which~~and ~~typically~~development ~~occurs~~tax atcredit ~~shipment.~~was ~~For~~extended or ~~these products, we typically have no significant obligations subsequent to shipment~~reinstated. Our Iftax arate ~~significant~~could ~~obligation were to exist, we would defer revenue~~also ~~recognition~~be ~~until~~impacted ~~such~~by ~~obligation~~our ~~was~~adjustment ~~satisfied.~~of ~~All~~certain ~~shipping~~tax ~~costs~~accounts ~~are~~if ~~included~~the instatute ~~cost~~ of limitations ~~revenues~~were into ~~our~~expire ~~consolidated~~on ~~statements~~open oftax ~~income~~years.

~~Contracts~~During ~~for~~the ~~our~~three ~~GeoProbe,~~months ~~Orion~~ended ~~and~~March ~~Beamer products are typically multiple-element arrangements~~31, ~~which means they involve multiple deliverables. We~~2004, ~~determine~~our ~~the~~effective ~~fair~~tax ~~value~~rate of ~~each~~approximately ~~of the contract deliverables using vendor-specific objective evidence, or VSOE~~24.1% ~~VSOE~~was ~~for~~also ~~each~~impacted ~~element~~by ~~is based on~~ the ~~price for which we would sell the element on a stand-alone basis. We offer our customers product~~effect ~~support~~of ~~services,~~adjustments ~~which~~to ~~include~~ the ~~correction~~balance of ~~software problems, telephone access to~~ our ~~technical~~state ~~personnel~~tax liability and the ~~right~~balance toof ~~receive unspecified product updates, upgrades and enhancements, when and if they become available. Revenues from these~~our ~~services,~~deferred ~~including~~tax ~~post-contract~~assets ~~support included in initial licensing fees, are recognized ratably over the contract period. Post-contract support included in the initial licensing fee are allocated from the total contract amount~~ based on ~~the~~information ~~fair value~~developed ofin ~~these services determined using VSOE. Revenues from other services, such as training, are recognized when~~ the ~~services have been completed~~quarter.

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

~~Page~~We 9have elected to follow Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for our employee stock options. Under APB 25, if the exercise price of 35an employee’s stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. At March 31, 2004, we had three stock-based compensation plans covering employees and directors. We account for stock-based compensation for non-employees under the fair value method prescribed by Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation. Through March 31, 2004, there have been no grants to non-employees other than grants to our non-employee directors under our automatic option grant program. As of March 31, 2004, unearned stock compensation related to restricted stock grants was approximately $2.4 million. As of December 31, 2003, unearned stock compensation related to restricted stock grants was approximately $2.6 million.

~~Table of Contents~~10

~~Income~~Although ~~Taxes~~SFAS 123 allows us to continue to follow the present APB 25 guidelines in accounting for employee stock options and employee stock purchase rights, we are required to disclose pro forma net income and net income per share as if we had adopted SFAS 123 in accounting for employee stock options and restricted stock issuances and employee stock purchase rights. The pro forma impact of applying SFAS 123 in the three months ended March 31, 2004 and the three months ended March 31, 2003 will not necessarily be representative of the pro forma impact in future periods. Our pro forma information is as follows (in thousands, except per share data):

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

	Three months ended March 31,
	2004			2003

Net income, as reported	$	3,276		$	3,255
Stock compensation expense recorded under the intrinsic value method, net of income taxes	135			96
Pro forma stock compensation expense computed under the fair value method, net of income taxes	(1,988		)	(2,499		)
Pro forma net income	$	1,423		$	852

Basic earnings per common share, as reported	$	0.08		$	0.08
Diluted earnings per common share, as reported	$	0.08		$	0.08

Pro forma basic earnings per common share	$	0.04		$	0.02
Pro forma diluted earnings per common share	$	0.04		$	0.02

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

Stock Options

	Three months ended March 31,
	2004			2003

Volatility	0.89			0.97
Weighted-average expected lives	3.00			3.68
Expected dividend yields	—			—
Weighted-average risk-free interest rates	1.94		%	2.10		%
Weighted-average fair value of options granted	$	7.23		$	4.15

We have elected to follow Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for our employee stock options. Under APB 25, if the exercise price of an employee’s stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. At September 30, 2003, we had three stock-based compensation plans covering employees and directors. We account for stock-based compensation for non-employees under the fair value method prescribed by Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation. Through September 30, 2003, there have been no grants to non-employees other than grants to our non-employee directors under our automatic option grant program. As of September 30, 2003, unearned stock compensation related to restricted stock grants was approximately $0.3 million. We had no unearned stock compensation at September 30, 2002. 11

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

Page 10 of 35

	Three months ended March 31,
	2004			2003

Volatility	0.91			0.98
Weighted-average expected lives	0.50			0.50
Expected dividend yields	—			—
Weighted-average risk-free interest rates	1.15		%	1.32		%
Weighted-average fair value of employee stock purchase rights	$	5.17		$	2.52

~~Table~~Note of2 ~~Contents~~- Related Party Transactions

	Three months ended September 30,						Nine months ended September 30,
	2003			2002			2003			2002
Net income, as reported	$	2,778		$	806		$	8,304		$	4,871
Stock compensation expense recorded under the intrinsic value method, net of income taxes		25			—			144			—
Pro forma stock compensation expense computed under the fair value method, net of income taxes		(1,083	)		(1,566	)		(2,093	)		(9,818	)
Pro forma net income (loss)	$	1,720		$	(760	)	$	6,355		$	(4,947	)
Basic earnings per common share, as reported	$	0.07		$	0.02		$	0.21		$	0.10
Diluted earnings per common share, as reported	$	0.07		$	0.02		$	0.21		$	0.10
Pro forma basic earnings (loss) per common share	$	0.04		$	(0.02	)	$	0.16		$	(0.11	)
Pro forma diluted earnings (loss) per common share	$	0.04		$	(0.02	)	$	0.16		$	(0.11	)

Epygi Technologies, Ltd., an entity controlled by Samuel S. Simonian, one of our founders and chairman of our board, currently performs development services for us pursuant to a consulting agreement for which it is paid a monthly fee per full-time programmer plus reimbursement of reasonable business expenses. We expensed approximately $0.1 million for these services in both the three months ended March 31, 2004 and the three months ended March 31, 2003.

~~Inputs~~On January 21, ~~used~~2003, ~~for~~we ~~the~~repurchased in a privately-negotiated transaction ~~fair~~8,969,984 ~~value~~restricted ~~method~~shares ~~for~~of our ~~employee~~common stock ~~options~~from ~~are~~Mark A. Weinzierl, one of our founders and a member of our board of directors until the closing of the transaction, for an aggregate cash purchase price of approximately $35.4 million. We funded the transaction with available cash. The shares repurchased represented approximately 19% of our total shares outstanding immediately prior to the transaction. Effective as ~~follows:~~of the closing of the transaction, Mr. Weinzierl resigned from our board of directors.

	Three months ended September 30,						Nine months ended September 30,
	2003			2002			2003			2002
Volatility		0.92			0.99			0.95			0.99
Weighted-average expected lives		3.69			3.68			3.25			2.72
Expected dividend yields		—			—			—			—
Weighted-average risk-free interest rates		2.73	%		2.27	%		1.83	%		2.62	%
Weighted-average fair value of options granted	$	7.94		$	3.57		$	5.38		$	5.56

Note 3 - Earnings Per Share

~~Inputs~~The following ~~used~~table ~~for~~sets forth the ~~fair~~ ~~value~~computation ~~method~~of ~~for~~basic ~~our~~and ~~employee~~diluted ~~stock~~earnings ~~purchase~~per share ~~rights~~(in ~~are~~thousands, asexcept ~~follows:~~per share amounts):

	Three months ended September 30,							Nine months ended September 30,
	Three months ended March 31,
	2003				2002			2003			2002
	2004			2003
Volatility		0.95				0.99			0.97			1.02
Numerator:
Weighted-average expected lives		0.50				0.50			0.50			0.50
Net income for basic and diluted earnings per share	$	3,276		$	3,255
Expected dividend yields		—				—			—			—
Denominator:
Weighted-average risk-free interest rates		1.18	%			1.53	%		1.31	%		1.70	%
Denominator for basic earnings per share — weighted-average shares	39,119			40,395
Weighted-average fair value of employee stock purchase rights	$	3.78			$	2.58		$	2.95		$	3.10
Dilutive securities: Employee stock options and purchase rights	669			168
Denominator for diluted earnings per share — adjusted weighted-average shares	39,788			40,563
Basic earnings per common share	$	0.08		$	0.08
Diluted earnings per common share	$	0.08		$	0.08

~~Note 2—Related Party Transactions~~ 12

OnNote ~~January~~5 ~~21, 2003, we repurchased in a privately~~-~~negotiated~~ Segment ~~transaction 8,969,984 restricted shares of our common stock from Mark A. Weinzierl, one of our founders and a member of our board of directors~~ Information

~~Page~~We 11operate in a single industry segment, providing communications software solutions and associated services to our customers through our sales personnel and certain foreign resellers. As a result, the financial information disclosed in this report represents all material financial information related to our sole operating segment. The geographic distribution of 35our revenues as a percentage of total revenues is as follows:

	Three months ended March 31,
	2004		2003

United States	37.8	%	19.2	%
Export:
Asia/Pacific	5.2		8.0
Europe, Middle East and Africa	54.7		71.2
Other	2.3		1.6
Total export	62.2		80.8
	100.0	%	100.0	%

~~until~~In the ~~closing~~three ofmonths ~~the~~ended ~~transaction~~March 31, 2004, ~~for~~revenues anfrom ~~aggregate~~one ~~cash~~international ~~purchase~~wireline ~~price~~customer ofaccounted for approximately ~~$35.4~~18% ~~million.~~of Wetotal ~~funded~~revenues, ~~the~~revenues ~~transaction~~from ~~with~~one ~~available~~international ~~cash. The~~wireless ~~shares~~customer ~~repurchased~~accounted ~~represented~~for approximately 1915% of ~~our~~ total ~~shares~~revenues, ~~outstanding~~revenues ~~immediately~~from ~~prior~~one domestic towireless ~~the~~customer ~~transaction.~~accounted ~~Effective~~for as11% of ~~the~~total ~~closing~~revenues and revenues from one domestic wireline customer accounted for 11% of total revenues. For the ~~transaction,~~three ~~Mr.~~months ~~Weinzierl~~ended ~~resigned~~March 31, 2003, revenues from ~~our~~one ~~board~~international wireline customer accounted for approximately 44% of ~~directors.~~total revenues.

~~Epygi~~We ~~Technologies,~~have ~~Ltd.,~~no ansignificant ~~entity~~long-lived ~~controlled by Samuel S. Simonian, one of~~assets ~~our~~deployed ~~founders~~outside ~~and chairman~~ of our board, currently performs development services for us pursuant to a consulting agreement for which it is paid a monthly fee per full-time programmer plus reimbursement of reasonable business expenses. We expensed approximately $0.1 million for these services in the ~~three~~United ~~months ended September 30, 2003 and approximately $0~~States.3 million for these services in the three months ended September 30, 2002. We expensed approximately $0.3 million for these services in the nine months ended September 30, 2003 and approximately $0.8 million for these services in the nine months ended September 30, 2002.

~~Note~~Item 2. Management’s Discussion ~~3—Restructuring~~and Analysis of Financial Condition and Results of Operations

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

~~Note~~This ~~4—Earnings~~Quarterly ~~Per~~Report ~~Share~~on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than historical or current facts, including, without limitation, statements about our business strategy, plans and objectives of management and our future prospects, are forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are reasonable, such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from these expectations. Such risks and uncertainties include, without limitation, the following:

~~The~~• our operating ~~following~~results ~~table~~are ~~sets~~difficult ~~forth~~to ~~the~~predict ~~computation of basic~~ and ~~diluted~~are ~~earnings~~likely ~~per~~to ~~share~~vary ~~(in~~significantly from ~~thousands,~~quarter ~~except~~to ~~per~~quarter ~~share~~in ~~amounts):~~the future;

	Three months ended September 30,				Nine months ended September 30,
	2003		2002		2003		2002
Numerator:
Net income for basic and diluted earnings per share	$	2,778	$	806	$	8,304	$	4,703
Denominator:
Denominator for basic earnings per share—weighted-average shares		38,612		47,011		39,129		46,913
Dilutive securities: Employee stock options and purchase rights		626		32		332		105
Denominator for diluted earnings per share—adjusted weighted-average shares		39,238		47,043		39,461		47,018
Basic earnings per common share	$	0.07	$	0.02	$	0.21	$	0.10
Diluted earnings per common share	$	0.07	$	0.02	$	0.21	$	0.10

• we could be materially harmed in the event of a general economic slowdown, decreased spending by communications carriers and equipment manufacturers or consolidations or bankruptcies involving our current or prospective customers;

~~Note~~• we ~~5—Segment~~could ~~Information~~be materially harmed if demand for our products is less than we anticipate;

We• we ~~operate~~could inbe materially aharmed ~~single~~if ~~industry~~the ~~segment,~~market ~~providing communications~~for ~~software~~current- ~~solutions~~ and ~~associated~~next-generation ~~services~~network products ~~to our customers through our sales personnel~~ and ~~certain~~applications ~~foreign~~fails ~~resellers. As a result, the financial information disclosed in this report represents all material financial information related~~ to ~~our~~develop ~~sole operating segment. The geographic distribution of our revenues~~ as awe ~~percentage~~currently ~~of total revenues is as follows:~~ anticipate;

~~Page 12 of 35~~ 13

~~Table~~• we expect to face increased competition that could result in price reductions and reduced margins, as well as loss of ~~Contents~~market share; and

	Three months ended September 30,				Nine months ended September 30,
	2003		2002		2003		2002
United States	36.8	%	34.0	%	28.0	%	27.3	%
Export:
Asia/Pacific	8.2		5.3		8.3		9.1
Europe, Middle East and Africa	53.5		58.9		61.7		60.1
Other	1.5		1.8		2.0		3.5
Total export	63.2		66.0		72.0		72.7
	100.0	%	100.0	%	100.0	%	100.0	%

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

InThese ~~the~~risks ~~three~~and ~~months ended~~uncertainties ~~September~~are ~~30,~~beyond ~~2003,~~our ~~revenues~~control ~~from~~and, ~~one~~in ~~domestic wireline customer accounted for approximately 21% of total revenues~~many cases, ~~revenues~~we ~~from~~cannot ~~one~~predict ~~international~~the ~~wireline~~risks ~~customer~~and ~~accounted~~uncertainties ~~for~~that ~~approximately~~could ~~18%~~cause ofour actual ~~total~~results ~~revenues~~to ~~and~~differ ~~revenues~~materially from ~~another international~~those ~~wireline~~indicated ~~customer~~by ~~accounted~~the ~~for~~forward-looking statements. ~~approximately~~When ~~18%~~used ofin ~~total~~this ~~revenues.~~document, In the ~~three~~words ~~months~~“believes,” ~~ended~~“plans,” “expects,” ~~September~~“anticipates,” 30“intends,” ~~2002~~“continue,” ~~revenues~~“may,” ~~from~~“will,” ~~one international wireline customer accounted for approximately 16% of total revenues and revenues from~~“could,” ~~another~~“should,” ~~international~~“future,” ~~wireline customer accounted for approximately 14% of total revenues. In the nine months ended September 30~~“potential,” ~~2003~~“estimate,” ~~revenues~~or ~~from~~the ~~one~~negative ~~international wireline customer accounted for approximately 22%~~ of ~~total~~such ~~revenues.~~terms ~~In the nine~~and ~~months~~similar ~~ended~~expressions ~~September~~as ~~30,~~they ~~2002,~~relate ~~revenues~~to ~~from~~us ~~one~~or ~~international~~our ~~wireline~~management ~~customer~~are ~~accounted~~intended ~~for~~to identify ~~approximately~~forward-looking ~~21% of total revenues~~statements.

WeThe ~~have~~following nodiscussion ~~significant~~should ~~long-lived~~be ~~assets~~read ~~deployed~~in ~~outside~~conjunction with, and is qualified in its entirety by, the condensed consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report and the ~~United~~condensed consolidated ~~States~~financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K filed with the SEC on January 30, 2004. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.

~~Note 6—Recent Accounting Pronouncements~~ Overview

InInet ~~July 2002~~Technologies, ~~the Financial Accounting Standards Board, or FASB, issued SFAS No~~Inc. ~~146,~~is ~~Accounting~~a ~~for~~global ~~Costs Associated~~provider ~~with~~of ~~Exit~~communications orsoftware ~~Disposal~~products ~~Activities.~~that ~~This~~enable ~~statement~~communications ~~nullifies~~carriers ~~Emerging~~to ~~Issues~~more strategically ~~Task~~and ~~Force,~~profitably oroperate ~~EITF~~their ~~Issue No~~businesses. ~~94-3,~~Our ~~Liability~~Unified ~~Recognition~~Assurance Solution ~~for Certain Employee Termination Benefits~~ and ~~Other~~our ~~Costs~~Diagnostics toproducts ~~Exit~~help anour ~~Activity~~customers ~~(including~~reduce ~~Certain~~capital ~~Costs~~and ~~Incurred~~operating inexpenditures, aimprove ~~Restructuring).~~customer ~~The~~acquisition ~~standard~~and ~~requires~~retention ~~companies~~rates, protect toand ~~recognize~~grow ~~costs~~revenues, ~~associated~~and ~~with~~more ~~exit~~quickly orand ~~disposal~~effectively ~~activities~~develop ~~when~~products ~~they are incurred rather than at the date of commitment to an exit~~ or ~~disposal plan~~ services. ~~This~~Our ~~statement~~products isaddress ~~applicable to~~next-generation ~~exit~~networks, orincluding ~~disposal~~mobile ~~activities~~data and ~~initiated~~voice-over-packet ~~after December 31~~technologies, ~~2002.~~and ~~The~~traditional ~~adoption of this standard did not have a significant effect on our financial position or results of operations~~networks.

~~Note~~This ~~7—Subsequent~~Management’s ~~Event~~Discussion and Analysis of Financial Condition and Results of Operations provides information that our management believes to be necessary to achieve a clear understanding of our financial statements and results of operations.

InOur ~~October~~management ~~2003,~~monitors ~~we completed an underwritten secondary offering of our common stock. All shares were offered by two of our founders, Elie S. Akilian, our president, chief executive officer~~ and ~~director,~~analyzes ~~and~~a ~~Samuel S. Simonian, the chairman~~ number of ~~our~~key ~~board~~performance ofindicators ~~directors. Since we did not issue any new shares, we did not receive any of the proceeds from the sale of common stock. We effected the offering pursuant to a demand made by the selling stockholders~~ in ~~accordance~~order ~~with rights granted~~ to ~~them~~manage ~~under~~our abusiness ~~registration rights agreement dated July 23, 1998. We are paying all of the expenses of the offering incurred by us~~ and ~~certain~~evaluate ~~fees and expenses~~our offinancial ~~the selling stockholders, excluding underwriting discounts~~ and ~~commissions.~~operating ~~At September 30, 2003, we had expensed approximately $0~~performance.~~3 million of accounting, legal and professional fees and anticipate additional expenses of approximately $0.1~~ ~~million~~Those inindicators ~~the fourth quarter of 2003.~~ include:

~~Page~~• Revenues. We 13derive revenues from product and license fees and services relating to our products. These revenues vary based on such factors as demand for our products, the number and size of 35transactions within the reporting period and the impact of changes in our sales prices. In addition to monitoring the amount of our product and license fees revenues, services revenues and total revenues, we also consider revenue concentration by customer and by geographic region to be possible indicators of current and future trends in our business.

~~Table~~• Cost of revenues ~~Contents~~and gross margins. We strive to control our cost of revenues and thereby maintain or improve our gross margins. The major items impacting cost of product and license fees are hardware and third-party software, personnel and overhead expenses. Hardware and third-party software costs will vary significantly from quarter to quarter based on the relative mix of implementations during a reporting period. Implementations related to new systems and expansion projects involving increased physical network coverage involve a greater use of hardware. In contrast, expansions of system capacity and software-only application sales require less hardware. Cost of services is driven primarily by personnel expenses. These costs tend to fluctuate as a result of the relative mix of product support and training activities during a specific period.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~ 14

~~Forward-Looking~~• Operating expenses. Operating ~~Statements~~expenses are substantially driven by personnel and overhead expenses. Other significant operating expenses that we monitor include travel, professional fees and facilities and communication expenses.

~~This~~• Liquidity and ~~Quarterly~~cash ~~Report~~flows. The onprimary source ~~Form 10-Q contains forward-looking statements within the meaning~~ of ~~Section~~our ~~27A~~liquidity ofis ~~the~~our ~~Securities~~cash ~~Act~~reserves ~~of 1933, as amended,~~ and ~~Section~~ ~~21E~~short-term ofinvestments. The ~~the~~primary ~~Securities~~driver ~~Exchange Act~~ of ~~1934, as amended. All statements other than historical or current facts, including, without limitation, statements about~~ our ~~business~~cash ~~strategy,~~flows ~~plans~~is ~~and objectives of management and~~ our ~~future~~ ~~prospects,~~net ~~are~~income. From ~~forward-looking~~period ~~statements.~~to ~~Although~~period, we see ~~believe~~fluctuations ~~that the expectations reflected~~ in ~~such~~various ~~forward-looking statements are reasonable~~items, ~~such~~including ~~forward-looking~~our ~~statements~~working ~~are~~capital ~~subject~~accounts, capital toexpenditures ~~risks~~ and ~~uncertainties~~proceeds ~~that could cause actual results to differ materially~~ from ~~these~~the ~~expectations.~~exercise ~~Such~~of ~~risks~~employee stock options and ~~uncertainties~~stock ~~include, without limitation, the following:~~ purchases.

• Balance sheet. We ~~Our~~view ~~operating~~cash, short-term ~~results~~investments, ~~are~~working ~~difficult~~capital, toinventory, ~~predict~~accounts receivable balances and ~~are~~days ~~likely~~sales tooutstanding ~~vary~~as ~~significantly~~important ~~from~~indicators ~~quarter~~of toour ~~quarter in the future;~~financial health.

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

~~• We could be materially harmed if demand for our products and applications is less than we anticipate;~~Revenues

•The Wefollowing table ~~could~~sets beforth, ~~materially~~for ~~harmed if~~ the ~~market~~periods ~~for~~indicated, ~~current-~~a ~~and next~~year-~~generation~~over-year ~~network~~comparison ~~products~~of ~~and~~the key ~~applications~~components ~~fails~~of toour ~~develop as we currently anticipate;~~revenues:

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

($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$		%
Product and license fees	$	19.6		$	17.5		$	2.1	12	%
Services	7.6			7.5			0.1		1
Total revenues	$	27.2		$	25.0		$	2.2	9	%

Top 10 customers as % of total revenues	73		%	69		%

Revenues from international markets:
Asia/Pacific	5.2		%	8.0		%
Europe, Middle East and Africa	54.7			71.2
Other	2.3			1.6
Total	62.2		%	80.8		%

•Product ~~Other~~and ~~risks~~license ~~indicated~~fees. The increase ~~below~~in ~~under~~product and license fees for the ~~caption~~three ~~“Risk~~months ~~Factors~~ended March 31, 2004 compared to March 31, 2003 reflected a 50% increase in the number of Unified Assurance product implementations.” This increase was somewhat mitigated by a lower average value per implementation and a decrease in our sales prices compared to the same prior-year period. Prices for our most basic GeoProbe system generally decreased by approximately 8% in the three months ended March 31, 2004 compared to the same prior-year period. We experience the greatest pressure on sales prices in highly competitive situations involving prospective customers and we anticipate that we will continue to experience pricing pressure for our products during the remainder of 2004.

~~These~~Services. In ~~risks~~the ~~and~~three ~~uncertainties~~months ~~are~~ended ~~beyond~~March 31, ~~our~~2004 ~~control~~compared ~~and,~~to inthe ~~many~~same prior-year ~~cases~~period, wethe ~~cannot~~increase ~~predict~~in ~~the~~services ~~risks~~revenues ~~and~~was ~~uncertainties~~primarily attributable ~~that~~to ~~could~~a ~~cause~~larger ~~our~~installed ~~actual~~base ~~results~~of toproducts ~~differ~~with ~~materially~~customers ~~from~~for ~~those~~which ~~indicated~~we provide product support services, offset by ~~the~~continued ~~forward-looking~~price ~~statements.~~pressure ~~When~~on ~~used~~prices infor product ~~this~~support ~~document,~~contracts. In the ~~words~~three months ~~“believes,”~~ended ~~“plans~~March 31,” ~~“expects~~2004,” ~~“anticipates,”~~approximately 87% of our total revenues were ~~“intends,”~~from ~~“continue,”~~expansions ~~“may,”~~of ~~“will,”~~existing ~~“could,”~~systems. ~~“should,”~~Going ~~“future~~forward,” ~~“potential,”~~we ~~“estimate,”~~expect to sell additional applications to or expand the ~~negative~~footprint of ~~such~~our ~~terms~~products with existing customers, and ~~similar~~to ~~expressions~~add asnew ~~they relate~~customers, towhich usshould orcontinue to increase our ~~management~~installed ~~are~~base ~~intended~~of toproducts ~~identify~~and ~~forward-looking~~corresponding ~~statements.~~services revenues;

The following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 8-K filed with the SEC on September 18, 2003. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods. 15

~~Overview~~however, we expect that continued sales pressure on prices may partially offset the effect of this anticipated increase in our installed base.

~~Inet~~Concentration ~~Technologies,~~of ~~Inc~~revenues. isIn athe ~~global~~three ~~provider~~months ended March 31, 2004, revenues from one international wireline customer accounted for approximately 18% of ~~communications~~total revenues, ~~software~~revenues ~~products~~from ~~that~~one ~~enable~~international ~~communications~~wireless ~~carriers~~customer toaccounted ~~more~~for approximately ~~strategically~~15% ~~and~~of ~~profitably~~total revenues, revenues from one domestic wireless ~~operate~~customer ~~their~~accounted ~~businesses.~~for ~~Our~~approximately ~~Unified~~11% ~~Assurance~~of ~~Solution~~total revenues and ~~our~~revenues ~~Diagnostics~~from one ~~products~~domestic ~~help~~wireline ~~our~~customer ~~customers~~accounted ~~reduce~~for ~~capital~~11% ~~and~~of ~~operating~~total ~~expenditures~~revenues. For the three months ended March 31, 2003, ~~improve~~revenues from one international wireline customer ~~acquisition~~accounted ~~and~~for approximately ~~retention~~44% ~~rates,~~of ~~protect~~total ~~and~~revenues. ~~grow~~A large percentage of our revenues are typically derived from a small number of customers, ~~and~~the ~~more~~specific ~~quickly~~make ~~and~~up of ~~effectively~~which ~~develop~~typically ~~products~~varies orfrom ~~services.~~one ~~Our~~quarter ~~products~~to ~~address~~the next~~-generation~~. On ~~networks~~a quarterly basis, ~~including~~the ~~mobile~~10 ~~data~~largest ~~and~~customers ~~voice-over-packet~~for ~~technologies~~the quarter typically account for approximately 50% to 80% of total revenues. For the three months ended March 31, 2004, ~~and~~approximately ~~traditional~~73% ~~networks~~of our revenues were derived from our 10 largest customers for that period. We expect these trends to continue for the foreseeable future.

~~Page~~International 14revenues. Variations in the percentage of 35total revenues derived from international markets primarily occur as a result of the concentration of revenues in a particular period from a small number of customers and the economic conditions in the regions in which we operate. For the remainder of 2004, we expect revenues from international markets to represent the majority of our total revenues.

~~Table~~Cost of ~~Contents~~Revenues

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

Results of Operations

Cost of Revenues ($ in millions)	Three months ended March 31,				Variance 2004 vs. 2003
	2004		2003		$			%
Product and license fees	$	5.2	$	2.9	$	2.3		79	%
Services	3.2		4.2		(1.0		)	(24	)
Total cost of revenues	$	8.4	$	7.1	$	1.3		18	%

Average headcount	127		121

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

Gross Margin ($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$			%
Product and license fees	$	14.4		$	14.6		$	(0.2	)	(1	)%
Services	4.4			3.4			1.0			29
Total gross margin	$	18.8		$	18.0		$	0.8		4	%

Gross margin as a percentage of revenues:
Gross margin – product and license fees	73.4		%	83.4		%
Gross margin – services	57.9			44.6
Gross margin – total	69.1			71.8

	Three months ended September 30,				Nine months ended September 30,
	2003		2002		2003		2002
Revenues:
Product and license fees	69.4	%	71.5	%	69.7	%	73.9	%
Services	30.6		28.5		30.3		26.1
Total revenues	100.0		100.0		100.0		100.0
Cost of revenues:
Product and license fees	18.1		30.1		18.2		27.6
Services	14.4		13.0		14.7		12.3
Total cost of revenues	32.5		43.1		32.9		39.9
Gross Profit:
Product and license fees	51.3		41.4		51.5		46.3
Services	16.2		15.5		15.6		13.8
Total gross profit	67.5		56.9		67.1		60.1
Operating expenses:
Research and development	28.5		30.3		29.2		29.6
Sales and marketing	14.9		15.7		14.4		16.3
General and administrative	9.4		7.9		9.0		7.8
Restructuring costs	—		1.0		—		0.3
Total operating expenses	52.8		54.9		52.6		54.0
Income from operations	14.7		2.0		14.5		6.1
Other income	0.6		2.7		1.1		2.9
Income before provision for income taxes	15.3		4.7		15.6		9.0
Provision for income taxes	4.6		1.2		4.7		2.7
Net income	10.7	%	3.5	%	10.9	%	6.3	%

Product and license fees. Cost of product and license fees consists primarily of hardware, third-party software, personnel and overhead expenses related to the integration, installation and configuration of our products. In the three months ended March 31, 2004 compared to the three months ended March 31, 2003, hardware costs increased approximately $1.4 million due to a majority of our revenues being derived from increasing the physical network coverage of existing systems for current customers, which

~~Page 15 of 35~~ 16

~~Table~~inherently involves a greater use of ~~Contents~~hardware. In addition, personnel costs increased approximately $0.3 million in the three months ended March 31, 2004 compared to the same prior-year period due to increased headcount and salary adjustments. We expect a slight increase in headcount during the remainder of 2004.

~~Revenues~~Services. Cost of services consists of expenses, primarily personnel costs, related to our product support, training and warranty activities. In the three months ended March 31, 2004 compared to the three months ended March 31, 2003, cost of services decreased due to a higher percentage of man-hours being used to perform product-related installations than service-related tasks, such as product support, training and warranty activities. Historically, cost of services as a percentage of services revenues has fluctuated as a result of the relative mix of product support and training activities during a specific period. We expect these fluctuations to continue into the foreseeable future.

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

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

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

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

($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$		%
Research and development	$	8.1		$	7.7		$	0.4	5	%
Percent of total revenues	29.9		%	30.7		%
Average headcount	250			247

~~International~~Research ~~revenues~~and development expenses consist primarily of personnel, contract labor and facilities expenses incurred by our research and development organization. InOur research ~~the~~and ~~three~~development ~~months~~efforts ~~ended~~include ~~September~~expenditures ~~30,~~relating ~~2003~~to new products and applications, ~~international~~and ~~revenues~~new ~~accounted~~features or enhancements for ~~approximately~~existing ~~63%~~products, primarily in the areas of ~~total~~next-generation ~~revenues~~wireless and packet-based ~~compared~~technologies. Research and development expenses increased in absolute dollars primarily due to ~~approximately~~increased staffing ~~66%~~dedicated to research and development activities and increased use of third-party ~~total~~research ~~revenues~~and development services, which was approximately $0.2 million more in the three months ended ~~September 30~~March 31, ~~2002.~~2004 Incompared to the three ~~nine~~ months ended ~~September 30~~March 31, 2003. As a percentage of total revenues, ~~international~~research and development expenses decreased primarily due to the increase in total revenues. We expect research and development expenses to remain relatively flat during the remainder of 2004.

~~Page~~Software 16development costs are expensed as incurred until technological feasibility has been established, at which time subsequent costs are permitted to be capitalized until the product is available for general release to customers. To date, either the establishment of 35technological feasibility of our products has substantially coincided with their general release, or costs incurred subsequent to the achievement of technological feasibility have not been material. As a result, software development costs qualifying for capitalization have been insignificant, and we have not capitalized any software development costs.

~~Table~~Sales ofand ~~Contents~~Marketing Expenses

The following ~~accounted~~table ~~for~~sets ~~approximately~~forth, ~~72%~~for ~~of total revenues compared to approximately 73% of total revenues in~~ the ~~nine~~periods ~~months ended September 30~~indicated, ~~2002. Variations in the percentage of total revenues derived from international markets may occur as~~ a ~~result~~year-over-year ofcomparison ~~the concentration~~ of ~~revenues in a particular period from a small number of customers and~~ the ~~economic conditions in the regions in which we operate. For~~ ~~the~~key ~~remainder~~components of ~~2003, we expect revenues from international markets to represent a substantial majority of~~ our ~~total~~sales ~~revenues.~~and marketing expenses:

~~Cost of Revenues~~ 17

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

($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$		%
Sales and marketing	$	4.3		$	3.5		$	0.8	23	%
Percent of total revenues	15.8		%	14.0		%
Average headcount	71			62

~~Cost~~Sales ~~of product~~ and marketing ~~license~~expenses ~~fees~~consist ~~was~~primarily ~~$14.0 million, or 26.1%~~ of ~~product~~expenses ~~and license~~associated ~~fees~~with ~~revenues~~personnel, including incommissions ~~the~~from ~~nine~~direct ~~months ended September 30~~sales, ~~2003~~travel, facilities and ~~$21.2 million~~marketing, orsuch as ~~37.3%~~trade ofshow ~~product~~ and ~~license~~advertising ~~fees revenues, in the nine months ended September 30, 2002~~expenses. The ~~decrease~~increases in ~~the~~sales ~~cost of product~~ and ~~license~~marketing ~~fees~~expenses ~~is primarily driven by the relatively higher software-based content of our product implementations experienced~~ in ~~the first nine months of the year. The major components of the decreases in~~ absolute dollars and as a percentage of ~~product~~total ~~and license fees~~ revenues were ~~decreased~~primarily ~~hardware~~attributable ~~costs~~to ofincreased personnel ~~approximately $3.8 million and decreased~~ costs ofdue ~~approximately~~to ~~$0.7~~increased ~~million associated with excess or obsolete inventory. We utilized inventory previously identified as excess~~headcount, ~~which~~salary ~~reduced~~adjustments ~~our~~and ~~reserve for~~increased ~~excess~~commissions ~~inventory~~which byreflect ~~$0.4~~higher ~~million,~~bookings ~~compared to an increase to the reserve for excess inventory of approximately $0.4 million~~ in the ~~nine~~three months ended ~~September 30~~ March 31, ~~2002.~~2004 Wecompared ~~also~~to ~~had~~the ~~absorption~~same ofprior-year $0period.6 We ~~million~~expect ofsales ~~labor~~ and ~~overhead~~marketing expenses to ~~inventory.~~increase in the remainder of 2004.

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

~~Page~~The 17following table sets forth, for the periods indicated, a year-over-year comparison of 35the key components of our general and administrative expenses:

($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$			%
General and administrative	$	2.3		$	2.4		$	(0.1	)	(4	)%
Percent of total revenues	8.3		%	9.7		%
Average headcount	46			42

~~Operating~~General ~~Expenses~~and administrative expenses consist primarily of personnel, facilities and professional expenses of our finance and accounting, legal and executive departments. The decrease in absolute dollars and as a percentage of total revenues was primarily attributable to decreased professional fees of approximately $0.2 million. In the three months ended March 31, 2003, professional fees were higher than the three months ended March 31, 2004 due to professional fees related to our repurchase of restricted common stock outstanding in January 2003. We expect general and administrative expenses to increase in the remainder of 2004.

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

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

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

($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$			%
Investment income	$	0.4		$	0.4		$	—		—
Foreign currency translation loss	(0.2		)	—			(0.2		)	—
Total other income	$	0.2		$	0.4		$	(0.2	)	(50	)%

Rate of return on average cash and short-term investments	0.9		%	1.0		%

Sales and marketing expenses. Sales and marketing expenses consist primarily of expenses associated with personnel, including commissions from direct sales, travel, facilities and marketing, such as trade show and advertising expenses. These expenses increased to $3.9 million in the three months ended September 30, 2003 from $3.6 million in the three months ended September 30, 2002. Sales and marketing expenses as a percentage of total revenues were 14.9% in the three months ended September 30, 2003 and 15.7% in the three months ended September 30, 2002. The increase in absolute dollars was primarily attributable to increased expenses related to tradeshows and other promotional activities. 18

~~Sales~~Other ~~and marketing expenses decreased to $11.0 million in the nine months~~income ~~ended~~consists ~~September~~primarily ~~30,~~of ~~2003~~interest ~~from~~income ~~$12.5~~earned ~~million~~on ~~for~~our ~~the~~cash ~~nine~~and ~~months~~cash ~~ended September 30, 2002. Sales~~ equivalents and ~~marketing~~investment ~~expenses~~income asearned aon ~~percentage~~our ofinvestment ~~total~~in ~~revenues were 14~~U.4%S. ~~for~~Treasury ~~the~~bills ~~nine months ended September 30, 2003,~~ and 16U.3%S. government ~~for~~agency ~~the~~discount ~~nine months ended September 30~~notes, ~~2002.~~partially ~~The~~offset ~~decreases~~by inforeign ~~absolute~~currency translation ~~dollars~~adjustments and aslosses aon ~~percentage~~the disposal of ~~total~~assets. The ~~revenues~~decrease ~~were~~in ~~attributable~~other toincome ~~decreased~~was ~~average headcount dedicated to sales and marketing activities and cost reduction efforts~~ primarily attributable ~~related~~ to ~~travel,~~the ~~which decreased~~overall ~~approximately~~decrease ~~$0.2~~in ~~million.~~interest ~~The~~rates ~~average~~received ~~headcount~~on of our investments ~~sales~~ and ~~marketing~~foreign ~~organization~~translation ~~was~~adjustments. 67Foreign incurrency ~~the~~translation gains ~~nine~~or ~~months~~losses ~~ended~~primarily ~~September~~arise ~~30,~~from ~~2003,~~translation ~~compared~~adjustments tofor 77our international ~~in the nine months ended September 30~~operations, ~~2002.~~including In the ~~current~~United ~~quarter,~~Kingdom weand ~~increased~~ German sales and support ~~marketing~~organizations ~~headcount slightly~~ and, weto ~~currently~~a ~~expect~~lesser toextent, ~~continue~~ to ~~increase~~the ~~our~~small ~~sales~~percentage ~~and~~of ~~marketing~~our business ~~headcount~~denominated ~~over~~in ~~the~~non-U.S. ~~next several quarters~~currencies. To Wedate, ~~anticipate~~we ~~that~~have ~~sales~~not ~~and~~engaged ~~marketing expenses will increase slightly~~ in ~~the~~hedging ~~last~~activities ~~quarter~~for ofour international ~~the~~operations ~~year,~~or ~~and~~our ~~that~~non-U.S. ~~going~~dollar ~~forward spending on sales and~~ business.

PageProvision 18for ofIncome 35 Taxes

~~Table~~The following table sets forth, for the periods indicated, a year-over-year comparison of ~~Contents~~our provision for income taxes:

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

($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$			%
Income tax expense	$	1.0		$	1.5		$	(0.5	)	(33	)%
Effective tax rate	24.1		%	32.1		%

~~General~~Federal ~~and administrative expenses. General and~~income ~~administrative~~taxes ~~expenses~~for ~~consist~~the ~~primarily~~periods ofpresented ~~personnel,~~have ~~facilities~~been ~~and~~calculated ~~legal~~on ~~and~~the ~~professional~~basis ~~expenses~~ of ~~our~~an estimated ~~finance,~~annual ~~legal and executive departments~~rate. Our ~~These~~effective tax ~~expenses~~rate ~~were~~during ~~$2.5 million in~~ the ~~three~~first ~~months~~quarter ~~ended~~differs ~~September~~from ~~30,~~the ~~2003~~35% ~~and~~statutory ~~$1.8~~corporate ~~million~~tax ~~the~~rate ~~three~~primarily ~~months~~due ~~ended~~to ~~September~~the ~~30,~~effect ~~2002. General and administrative expenses as a percentage~~ of ~~total~~the ~~revenues~~extraterritorial ~~were~~income ~~9.4%~~exclusion, research inand ~~the~~development ~~three~~tax ~~months ended September 30~~credits, ~~2003~~ and ~~7.9%~~adjustments into the ~~three~~balance ~~months~~of ~~ended~~our state ~~September~~tax ~~30,~~liability ~~2002. The increases in absolute dollars~~ and asthe abalance ~~percentage~~ of ~~total~~our ~~revenues~~deferred ~~were~~tax ~~primarily~~assets ~~attributable~~based toon information ~~increased~~developed ~~accounting,~~in ~~legal~~the ~~and professional fees of approximately $0~~quarter.4 For ~~million~~2004, ofwe ~~which~~currently ~~approximately~~anticipate ~~$0.3~~our ~~million~~annual ~~related~~effective totax arate ~~secondary~~will ~~public stock offering completed~~be inapproximately ~~October 2003~~29. 5%.

~~General~~Our ~~and administrative expenses~~financial ~~increased~~statements toreflect ~~$6.9~~net ~~million~~deferred intax ~~the~~assets ~~nine~~of ~~months ended September 30, 2003 from~~ $62.0 million inas ~~the~~of ~~nine~~March ~~months ended September 30~~31, 2004, ~~2002.~~comprised ~~General and administrative expenses as a percentage~~ of ~~total~~deductible ~~revenues~~temporary ~~were 9~~differences.0% We ~~for~~have ~~the~~concluded ~~nine~~that ~~months~~it ~~ended~~is ~~September 30,~~more ~~2003~~likely ~~and~~than ~~7.8%~~not ~~for~~that the ~~nine~~net deferred ~~months~~tax ~~ended~~assets ~~September~~will ~~30,~~be ~~2002.~~realized ~~The~~based ~~increases~~on inthe ~~absolute~~scheduling ~~dollars and as a percentage~~ of ~~total~~deferred ~~revenues~~tax amounts ~~were~~and ~~attributable~~projected totaxable ~~increased accounting~~income, ~~legal~~although ~~and~~we ~~professional~~cannot ~~fees~~assure ofyou ~~approximately~~that ~~$0.6 million primarily~~such ~~related~~assets towill ~~our~~be ~~repurchase~~realized. The amount of the ~~restricted~~net ~~common~~deferred ~~stock~~tax inassets ~~January~~actually ~~2003~~realized ~~and~~could avary ~~secondary~~if ~~public~~there ~~stock~~are differences ~~offering completed~~ in ~~October~~the ~~2003.~~timing Weor ~~expect~~amount ~~that~~of ~~general~~future ~~and~~reversals ~~administrative~~of ~~expenses~~existing ~~will~~deferred tax ~~remain~~amounts ~~flat~~ or ~~will~~changes ~~slightly decrease~~ in the ~~last~~actual ~~quarter~~ amounts of ~~2003.~~future taxable income.

~~Restructuring.~~Our anticipated Weannual ~~recorded~~effective atax ~~restructuring charge~~rate of approximately 29.5% for 2004 differs from the ~~three~~35% ~~months~~statutory ~~ended~~corporate ~~September~~tax ~~30,~~rate ~~2002~~primarily ofdue ~~approximately~~to ~~$0.4~~the ~~million~~effect ~~related~~of ~~primarily~~the extraterritorial toincome aexclusion ~~workforce~~and ~~reduction~~research ofand ~~approximately~~development 35tax ~~employees~~credits. This ~~The~~tax ~~reduction~~rate ~~affected~~currently ~~all~~reflects ~~areas~~the impact of ~~the~~research ~~company.~~and ~~The~~development ~~charge~~tax credits ~~consisted~~through ~~primarily~~June of2004 ~~employee severance~~at ofwhich ~~approximately~~time $0the statute expires.3 As ~~million~~such, ~~and~~our ~~professional~~effective ~~fees~~tax rate could be impacted if the research and ~~outplacement~~development ~~services~~tax ofcredit ~~approximately~~was ~~$0.1~~extended ~~million~~or reinstated. Our Attax ~~September~~rate ~~30,~~could ~~2003,~~also ~~the~~be impacted ~~balance~~by our adjustment of ~~these~~certain ~~costs~~tax ~~that~~accounts ~~remained~~if tothe bestatute ~~paid~~of limitations ~~was~~were ~~less~~to ~~than~~expire ~~$0.1~~on ~~million.~~open tax years.

~~Other~~Net Income ~~(Expense)~~

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

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

($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$		%
Net income	$	3.3		$	3.3		$	—	—
Percent of total revenues	12.0		%	13.0		%

~~Page~~ 19 ~~of 35~~

~~Table~~In terms of ~~Contents~~absolute dollars and as a percentage of total revenues, net income decreased slightly due to the significant decrease in gross margins, reflecting the higher hardware-based content in our product implementations in the three months ended March 31, 2004 compared to the three months ended March 31, 2003.

ProvisionLiquidity forand IncomeCapital Taxes Resources

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

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

($ in millions)	Three months ended March 31,						Variance 2004 vs. 2003
	2004			2003			$			%
Operating cash flows	$	(2.1	)	$	9.8		$	(11.9	)	(121	)%
Investing cash flows	(44.9		)	(0.9		)	(44.0		)	*
Financing cash flows	1.3			(34.8		)	36.1			*

Capital expenditures	$	0.9		$	0.9		—			—

Liquidity and Capital Resources

	March 31, 2004		December 31, 2003		$			%
Cash and cash equivalents	$	72.9	$	118.5	$	(45.6	)	(39	)%
Short-term investments	99.3		55.0		44.3			81
Accounts receivable, net	15.1		10.9		4.2			39
Inventories	9.0		7.9		1.1			14
Working capital	171.1		165.5		5.6			3

Days sales outstanding in accounts receivable, including unbilled receivables	51.2		43.0
Inventory turns	3.8		3.4

~~Since~~* ~~our inception, we have funded our operations and met our capital~~These ~~expenditure~~percentages ~~requirements~~are ~~primarily~~affected ~~through~~by ~~cash~~one-time ~~flows~~transactions ~~from operations~~ and, toare anot ~~lesser~~meaningful ~~extent during our initial years of operations, through bank borrowings. Our working capital decreased approximately 12%~~ to ~~$161.2 million at September 30, 2003~~the ~~from~~understanding ~~$182.5 million at December 31, 2002. We had $168.7 million in cash and cash equivalents at September 30, 2003, a decrease~~ of ~~$20.3~~our ~~million~~financial ~~from~~condition ~~$189.1 million in cash~~ and ~~cash~~results ~~equivalents at December 31, 2002. The decreases in cash and working capital are primarily attributable to our funding~~ of a privately-negotiated transaction that closed on January 21, 2003, under which we repurchased 8,969,984 restricted shares of common stock from Mark Weinzierl, one of our founders, for an aggregate cash purchase price of approximately $35operations.~~4 million.~~

~~Net~~Since ~~cash~~our ~~provided~~inception, bywe ~~operating~~have ~~activities~~funded ~~decreased~~our ~~approximately~~operations 7%and tomet ~~$15.6~~our ~~million~~capital expenditure ~~for~~requirements ~~the~~primarily ~~nine~~through ~~months~~cash ~~ended~~flows ~~September~~from ~~30,~~operations ~~2003~~and ~~from~~to ~~$16.8~~a lesser ~~million~~extent during our initial years of operations through bank borrowings. We have consistently invested the ~~same~~proceeds ~~period~~from our initial public offering in ~~2002.~~temporary investments, including cash, cash equivalents and short-term investments. The decrease in ~~net~~ cash ~~provided~~was offset by ~~operating activities~~an ~~was~~increase ~~primarily~~in ~~attributable~~short-term investments due to ~~changes~~our investment in ~~amounts~~U.S. ofTreasury ~~unbilled~~bills and ~~receivables,~~U.S. ~~inventories,~~government ~~accounts~~agency ~~payable,~~discount ~~other~~notes ~~assets~~with maturities greater than 90 days, but ~~accounts~~less ~~payable~~than one year, ~~accrued~~which ~~compensation~~are ~~and~~classified ~~other~~as ~~accrued~~short-term ~~liabilities~~investments.

~~Net~~Operating cash ~~used~~flows in ~~investing~~the ~~activities~~three ~~increased~~months ~~88%~~ended toMarch 31, ~~$2.9~~2004 compared ~~million~~to ~~for~~ the ~~nine~~ three months ended ~~September 30~~March 31, 2003 ~~from~~decreased ~~$1.6~~primarily ~~million~~due to ~~during~~changes ~~the same period~~ in ~~2002.~~trade ~~Net~~accounts ~~cash~~receivable ~~used in investing activities for both periods related to purchases of property~~ and ~~equipment.~~deferred revenues. In the ~~last~~three ~~quarter~~months ofended ~~2003~~March 31, 2004, weaccounts ~~anticipate~~receivable ~~that~~increased ~~cash~~due ~~used in~~to ~~investing~~increased ~~activities~~levels ~~will~~of ~~increase~~business ~~slightly~~and ~~from~~the timing ~~cash~~of ~~used~~billings infor ~~investing~~our ~~activities~~Unified inAssurance ~~prior~~product ~~quarters~~implementations.

Net cash used in ~~financing~~investing activities ~~was~~related ~~$33.0~~to ~~million~~purchases inof short-term investments and purchases of property and equipment. In the ~~nine~~three months ended ~~September 30~~March 31, ~~2003~~2004, ~~compared~~we toused ~~net~~$44.0 ~~cash~~million ~~provided~~to bypurchase short-term ~~financing~~investments. In ~~activities~~both the ofthree ~~$1.6~~months ~~million~~ended inMarch 31, 2004 and the ~~nine~~three months ended March 31, ~~September~~2003, we used $0.9 million to purchase property and equipment. We anticipate that cash used

~~Page~~ 20 ~~of 35~~

~~Table~~to purchase property and equipment will increase on a quarterly basis for the remainder of 2004 ~~Contents~~from levels experienced in the current quarter.

Net cash ~~30,~~provided ~~2002.~~by Infinancing activities in both the ~~nine~~three months ended ~~September 30~~March 31, 2004 ~~2003,~~and wethe ~~used~~three ~~approximately~~months ~~$35.4~~ended ~~million to repurchase 8~~March 31,~~969,984~~ ~~restricted~~2003 ~~shares of common stock in a privately-negotiated transaction. Net cash provided by financing activities in both periods~~ resulted from proceeds from the issuance of common stock upon the exercise of stock options and purchases under our employee stock purchase plan. In the three months ended March 31, 2003, we used approximately $35.4 million to repurchase 8,969,984 restricted shares of common stock in a privately-negotiated transaction.

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

At ~~September 30~~March 31, ~~2003~~2004, we had no long-term debt ~~or material commitments for capital expenditures~~. We believe that our current cash balances and expected future cash flows will be sufficient to meet our anticipated cash needs for working capital, capital expenditures and other activities for at least the next 12 months. Beyond that, if current sources are not sufficient to meet our needs, we may seek additional equity or debt financing. In addition, any material acquisition of other businesses, products or technologies or material investments in joint ventures could require us to obtain additional equity or debt financing. There can be no assurance that additional financing would be available on acceptable terms, if at all.

~~Accounting~~Off-Balance ~~Policies~~Sheet Arrangements and Contractual Obligations

InIt ~~preparing~~is not our ~~consolidated~~usual ~~financial~~business ~~statements~~practice into ~~conformity~~enter ~~with~~into ~~U.S. generally~~off-balance ~~accepted accounting principles~~sheet arrangements, orexcept ~~GAAP,~~for weoff-balance ~~use~~sheet ~~certain~~arrangements ~~estimates~~related ~~and~~to ~~assumptions~~inventory purchase ~~that~~commitments ~~affect the reported amounts~~ and ~~related~~operating ~~disclosures~~lease ~~and~~commitments, ~~may vary from actual results. We consider the following accounting policies~~ as ~~those~~disclosed ~~most important~~in to the ~~portrayal~~ table of ~~our~~contractual ~~financial~~obligations ~~condition and those that require the most judgment or the greatest use of estimates~~below. In addition, ~~Although~~it weis ~~believe~~not ~~that~~ our ~~estimates~~normal ~~and~~policy ~~assumptions~~to ~~are~~issue ~~reasonable,~~guarantees ~~actual results may differ, and such differences could be significant~~ to ~~our~~third ~~financial results~~parties.

~~Revenue~~We are obligated to make future payments under various contracts, ~~Recognition~~including non-cancelable inventory purchase commitments and the operating leases for our corporate office facility and our facilities near the cities of London, England; Frankfurt, Germany and Paris, France and in Milan, Italy. The following table summarizes our contractual cash obligations as of March 31, 2004 (in thousands):

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

	Remainder of 2004		2005		2006		2007		2008		Thereafter
Purchase commitments	$	3,209	$	—	$	—	$	—	$	—	$	—
Capital commitments	419		—		—		—		—		—
Operating leases	4,618		6,294		6,364		6,364		6,364		11,645
Total	$	8,246	$	6,294	$	6,364	$	6,364	$	6,364	$	11,645

~~Multiple-element arrangements.~~During ~~Contracts~~the ~~for~~remainder ~~our~~of ~~GeoProbe~~2004, ~~Orion~~we ~~and~~expect ~~Beamer~~quarterly capital ~~products~~expenditures ~~are~~to ~~typically~~increase ~~multiple~~slightly ~~element~~compared ~~arrangements,~~to ~~which~~the ~~means~~level ~~they~~experienced ~~involve multiple deliverables. We determine~~ in the ~~fair~~first ~~value~~three ofmonths ~~each~~ of ~~the contract deliverables using vendor-specific objective evidence, or VSOE~~2004. ~~VSOE for~~

~~Page~~Related Party ~~21 of 35~~ Transactions

~~Table~~Epygi Technologies, Ltd., an entity controlled by Samuel S. Simonian, one of ~~Contents~~our founders and chairman of our board, currently performs development services for us pursuant to a consulting agreement for which it is paid a monthly fee per full-time programmer plus reimbursement of reasonable business

each element is based on the price for which we would sell the element on a stand-alone basis. We offer our customers product support services, which include the correction of software problems, telephone access to our technical personnel and the right to receive unspecified product updates, upgrades and enhancements, when and if they become available. Revenues from these services, including post-contract support included in initial licensing fees, are recognized ratably over the service period. Post-contract support included in the initial licensing fee are allocated from the total contract amount based on the fair value of these services determined using VSOE. Revenues from other services, such as training, are recognized when the services have been completed. If we determine that we do not have VSOE on an undelivered element of an arrangement, we will not recognize revenue until all elements of the arrangement are delivered. This occurrence could materially impact our financial results because of the significant dollar amount of many of our contracts and the significant portion of total revenues that a single contract may represent in any particular period. 21

~~Trade~~expenses. We ~~Accounts~~expensed approximately $0.1 million for these services in both the ~~Receivable~~three months ended March 31, 2004 and ~~Allowance~~the ~~for~~three ~~Doubtful~~months ~~Accounts~~ended March 31, 2003.

~~A large~~On ~~portion~~January 21, of2003, ~~our~~we ~~revenues~~repurchased ~~and accounts receivable are attributable to our carrier customers~~ in ~~the communications industry and, to~~ a ~~lesser~~privately-negotiated ~~extent~~transaction 8,969,984 torestricted ~~our~~shares ~~equipment manufacturer customers who supply equipment into the communications industry. Our trade accounts receivable balance is recorded net~~ of ~~allowances~~our ~~for~~common ~~amounts~~stock ~~not expected to be collected~~ from ~~our~~Mark ~~customers~~A. ~~Because our accounts receivable are usually unsecured~~Weinzierl, weone ~~periodically evaluate the collectibility~~ of our ~~accounts~~founders ~~based on~~and a ~~combination~~member of ~~factors,~~our ~~including~~board aof ~~particular~~directors ~~customer’s~~until ~~ability to pay and~~ the ~~age~~closing of the ~~receivables. To evaluate a specific customer’s ability to pay~~ transaction, wefor ~~analyze~~an ~~the~~aggregate ~~customer’s~~cash ~~payment~~purchase ~~history,~~price ifof ~~any,~~approximately ~~financial statements or~~$35.4 ~~other~~million. ~~information~~We ~~provided~~funded by the ~~customer,~~transaction orwith ~~third-party credit analysis reports or other publicly-~~available ~~information~~cash. The Inshares ~~cases~~repurchased ~~where the evidence suggests a customer may not be able to satisfy its obligations to us, we set up a specific~~represented ~~reserve~~approximately in19% ~~an amount we determine appropriate for the perceived risk. Most~~ of our ~~contracts~~total ~~include~~shares ~~multiple~~outstanding ~~payment~~immediately ~~milestones,~~prior ~~some of which occur in advance of revenue recognition, which mitigates our risk both in terms of collectibility and adjustments~~ to ~~recorded revenue~~the transaction. Effective ~~Given~~as ~~that most~~ of ~~our~~the closing ~~customers are large public companies with substantial resources, we have not historically experienced significant losses on uncollectible accounts and our allowance has been less than 5%~~ of ~~recorded~~ ~~receivables. If~~ the ~~current downturn in the communications industry continues~~transaction, ~~the financial condition of our customers could deteriorate and they may not be able to meet their financial obligations to us~~Mr. IfWeinzierl ~~this~~resigned ~~were to occur, the net value realized~~ from our ~~receivables~~board ~~may~~of ~~be materially different from the net balance recorded on our balance sheet~~directors.

~~Inventory~~Accounting ~~Reserves~~ Policies

~~Inventories~~In ~~are~~preparing ~~recorded~~our ~~net~~condensed ofconsolidated ~~allowances~~financial ~~for~~statements ~~unsalable or obsolete raw materials, work-~~in~~-process~~ conformity ~~and~~with ~~finished goods~~U.S. Wegenerally ~~evaluate~~accepted ~~the~~accounting ~~status~~principles, ofwe ~~our~~use certain ~~inventory~~estimates onand aassumptions ~~quarterly basis to ensure~~ that ~~the~~affect ~~amount recorded in our financial statements reflects~~ the ~~lower~~reported ofamounts ~~our~~and ~~cost~~related disclosures orand ~~the~~may ~~value~~vary wefrom ~~expect~~actual toresults. We ~~receive~~consider ~~when we sell~~ the ~~inventory.~~following ~~This~~accounting ~~estimate~~policies isas ~~based~~those onmost ~~several~~important ~~factors, including the~~to ~~condition~~the ~~and~~portrayal ~~salability~~ of our ~~inventory~~financial condition and ~~the~~those ~~forecasted~~that ~~demand~~require ~~for~~ the ~~particular~~most judgment ~~products~~or ~~incorporating these components. Based on current backlog and expected orders, we forecast~~ the ~~upcoming~~greatest ~~usage~~use of ~~current stock~~estimates. ~~We record reserves for~~ ~~obsolete~~Although ~~and~~we ~~slow-moving~~believe ~~parts~~that ofour upestimates ~~to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process~~ and ~~finished~~assumptions ~~goods inventory typically relate to firm orders and, therefore,~~ are ~~not subject to obsolescence risk.~~reasonable, Ifactual ~~market~~results ~~conditions~~may ~~deteriorate or the expected future demand for our products otherwise decreases~~differ, orand ifsuch ~~changes~~differences ~~in our business strategy reduce our need for these components, our estimate of the carrying value of our inventory~~ could be ~~reduced~~significant byto our afinancial ~~material amount~~results.

~~Page~~Revenue ~~22 of 35~~ Recognition

~~Table~~General. We derive revenues primarily from product and license fees as well as services, which include training, warranty and product support services. The majority of ~~Contents~~the contracts for our Unified Assurance products contain multiple billing milestones, such as contract award, shipment, installation, ready for acceptance and acceptance, not all of which are associated with revenue recognition. Except as otherwise discussed below, revenues from product and license fees are recognized in the period that we have completed all hardware manufacturing and/or software development to contractual specifications, factory testing has been completed, the product has been shipped to the customer, the fee is fixed and determinable and collection of the fee is considered probable. When we have significant obligations subsequent to shipment, such as installation and system integration, revenues are recognized when there are no significant unfulfilled obligations. Revenues from arrangements that include significant acceptance terms and/or provisions and revenues from arrangements that include significant developmental items are recognized when acceptance has occurred. Revenues from our Diagnostics products are typically recognized when title and risk of loss pass to the customer, which typically occurs at shipment. For these products, we typically have no significant obligations subsequent to shipment. If a significant obligation were to exist, we would defer revenue recognition until such obligation was satisfied. All shipping costs are included in cost of revenues in our condensed consolidated statements of income.

~~Income~~Multiple-element ~~Taxes~~arrangements. Contracts for our Unified Assurance products typically involve multiple deliverables. We determine the fair value of each of the contract deliverables using vendor-specific objective evidence, or VSOE. VSOE for each element is based on the price for which we would sell the element on a stand-alone basis. We offer our customers product support services, which include the correction of software problems, hardware replacement, telephone access to our technical personnel and the right to receive unspecified product updates, upgrades and enhancements, when and if they become available. Revenues from these services, including post-contract support included in initial licensing fees, are recognized ratably over the service period. Post-contract support included in the initial licensing fee are allocated from the total contract amount based on the fair value of these services determined using VSOE. Revenues from other services, such as training, are recognized when the services have been completed. If we determine that we do not have VSOE on an undelivered element of an arrangement, we will not recognize revenue until all elements of the arrangement are delivered. This occurrence could materially impact our financial results because of the significant dollar amount of many

In the preparation of our provision for income taxes and determination of whether deferred tax assets will be realized in full or in part, we must estimate several factors. When it is more likely than not that all or some portion of the deferred tax asset will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that is determined not to be realizable. As of September 30, 2003 and December 31, 2002, a valuation for deferred tax assets was not deemed necessary. If the facts or financial results on which our estimates are based were to change, thereby impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of valuation allowance required in any given period. Additionally, our income tax returns are subject to review and examination in the various jurisdictions in which we operate. We are currently not aware of any issues that have been raised by taxing jurisdictions, and management believes that all income tax issues which may be raised as a result of such reviews and examinations in the future will be resolved with no material impact on our financial position or future results of operations. However, in the event there was an assessment by any of these jurisdictions, it could impact our tax provision. 22

~~Risk~~of ~~Factors~~our contracts and the significant portion of total revenues that a single contract may represent in any particular period.

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

IfA ~~any~~large portion of our revenues and accounts receivable are attributable to our carrier customers in the ~~following~~communications ~~risks~~industry ~~actually~~and, ~~occur~~to a lesser extent, ~~they~~to ~~could~~our equipment ~~materially~~manufacturer ~~harm~~customers who supply equipment into the communications industry. Our trade accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our ~~business~~customers. Because our accounts receivable are usually unsecured, we periodically evaluate the collectibility of our accounts based on a combination of factors, including a particular customer’s ability to pay and the age of the receivables. To evaluate a specific customer’s ability to pay, we analyze the customer’s payment history, if any, financial ~~condition~~statements or ~~results~~other ofinformation ~~operations~~provided by the customer, or third-party credit analysis reports or other publicly-available information. In ~~that~~cases ~~case~~where the evidence suggests a customer may not be able to satisfy its obligations to us, we set up a specific reserve in an amount we determine appropriate for the perceived risk. Most of our ~~trading~~contracts ~~price~~include multiple payment milestones, some of which occur in advance of revenue recognition, which mitigates our ~~common~~risk ~~stock~~both ~~could~~in ~~decline~~terms of collectibility and adjustments to recorded revenue. We have not historically experienced significant losses on uncollectible accounts and our allowance has been less than 5% of recorded receivables.

~~Our~~Inventory ~~quarterly financial results fluctuate and are difficult to predict.~~ Reserves

~~Our~~Inventories ~~quarterly~~are ~~financial~~recorded ~~results~~net ~~have~~of ~~varied~~allowances ~~significantly~~for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate on a quarterly basis the ~~past~~status ~~and~~of ~~are~~our ~~likely~~inventory to ensure ~~vary~~the ~~significantly~~amount ~~from~~recorded ~~quarter~~in our financial statements reflects the lower of our cost or the value we expect to ~~quarter~~receive inwhen we sell the ~~future~~inventory. This estimate is based on aseveral ~~number~~factors, including the condition and salability of ~~factors~~our inventory and the forecasted demand for the particular products incorporating inventory components. Based on current backlog, ~~many~~expected orders and other expected demand, we forecast the usage of ~~which~~current ~~are~~stock. We ~~outside~~record reserves for obsolete and slow-moving parts of ~~our~~up ~~control~~to 100% for excess parts with insufficient demand or obsolete parts. Amounts in Aswork-in-process aand ~~result~~finished goods inventory typically relate to firm orders and, ~~you~~therefore, ~~should~~are not ~~rely~~subject onto ~~our~~obsolescence ~~results~~risk. ofIf ~~operations~~market ~~during~~conditions deteriorate ~~any~~or ~~particular~~the ~~quarter~~expected asfuture andemand ~~indication~~for of our ~~future~~products ~~performance~~otherwise decreases, or if changes in ~~any~~our ~~quarterly~~business ~~period~~strategy orreduce ~~fiscal~~our ~~year.~~need ~~The~~for ~~factors~~these ~~that~~components, our ~~could~~estimate ~~affect~~of the carrying value of our ~~quarterly~~inventory ~~financial~~could ~~results~~be ~~include:~~reduced by a material amount.

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

•In the preparation ~~timing~~of our provision for income taxes and determination of whether deferred tax assets will be realized in full or in part, we must estimate several factors. When it is more likely than not that all or some portion of the ~~delivery~~deferred tax asset will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that is determined not to be realizable. As of March 31, 2004 and December 31, 2003, a valuation for deferred tax assets was not deemed necessary. If the facts ~~installation~~underlying our determination or financial results on which our estimates are based were to change in a manner impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of valuation allowance required in any given period. Additionally, our income tax returns are subject to review and examination ~~acceptance~~in the various jurisdictions in which we operate. We are currently not aware of any material issues that have been raised by taxing jurisdictions, and management believes that all income tax issues which may be raised as a result of such reviews and examinations in the future will be resolved with no material impact on our financial ~~products~~condition or future results of operations. However, in the event there was an assessment by any of these jurisdictions, it could impact our ~~customers;~~tax provision. In addition, we review the tax provision on a component basis and reflect changes in

~~• the timing of our development and introduction of new products or applications;~~23

•estimate in the ~~relative~~period ~~mix~~in ofwhich ~~product~~they ~~and~~are identified. The ~~license~~tax ~~fees~~provision ~~and~~is ~~services~~based on ~~fees~~tax ~~included~~statutes in ~~our~~affect ~~revenues;~~as of the date of the balance sheet.

~~• the relative mix of hardware- and software-related revenues in our total revenues;~~Risk Factors

•You should carefully consider the ~~relative~~risks described ~~percentages~~below ofbefore ~~products~~making ~~sold~~an ~~through~~investment decision regarding our ~~direct~~common stock. The risks and ~~indirect~~uncertainties ~~sales~~described ~~channels;~~below are not the only ones facing us. Additional risks and uncertainties that we do not presently know or that we currently deem immaterial may also impair our business operations. This document is qualified in its entirety by these risk factors.

•If ~~the~~any ~~timing~~ of ~~and~~the ~~level~~following ofrisks ~~our~~actually ~~investments~~occur, they incould ~~research~~materially ~~and~~harm ~~development~~our ~~activities~~business, ~~and~~financial ~~the~~condition ~~timing~~or results of operations. ~~and~~In ~~magnitude~~that ofcase, ~~our~~the ~~sales~~market ~~and~~price ~~marketing~~of ~~and~~our ~~general~~common ~~and~~stock ~~administrative~~could ~~expenses;~~decline.

•Our quarterly ~~changes~~financial ~~in,~~results fluctuate and ~~our~~are ~~ability~~difficult to ~~implement, our strategy; and~~predict.

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

~~Page~~• the size, 23timing, pricing structure and other terms of 35specific orders by our customers;

~~Table~~• the timing of ~~Contents~~the delivery to and the installation and acceptance of our products by our customers;

A• the timing ~~significant portion~~ of our ~~operating~~development ~~expenses, including rent~~ and ~~salaries,~~introduction isof ~~largely~~new ~~fixed~~products inor nature. Accordingly, if revenues are below expectations, our financial results are likely to be adversely and disproportionately affected because these operating expenses are not variable in the short term and cannot be quickly reduced to respond to unanticipated decreases in revenues. applications;

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

As• the relative amix ~~result~~ of ~~all~~hardware- ofand ~~the~~software-related ~~foregoing, we cannot assure you that our~~ revenues ~~will grow or remain stable~~ in ~~future periods or that we will remain profitable. In addition, in some future quarters~~ our ~~financial~~total ~~results may be below the expectations of public market analysts or investors. In such event, the market price of our common stock would likely fall.~~ revenues;

~~A further slowdown in communications spending, or consolidations or~~• the ~~bankruptcies~~relative inpercentages ~~the~~of ~~communications~~products ~~industry~~sold ~~could~~through ~~harm~~ our ~~business,~~direct ~~financial condition~~ and ~~results~~indirect ~~of operations.~~ sales channels;

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

~~Our~~• changes ~~financial~~in, ~~results~~and ~~could be materially harmed if demand for~~ our ~~new~~ability ~~products~~to isimplement, ~~less than we anticipate or the performance of~~ our ~~products~~strategy; ~~falls below the levels required by our customers.~~ and

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

~~Page~~A 24significant portion of 35our operating expenses, including rent and salaries, is largely fixed in nature. Accordingly, if revenues are below expectations, our financial results are likely to be adversely and disproportionately affected because these operating expenses are not variable in the short term and cannot be quickly reduced to respond to unanticipated decreases in revenues.

~~Table~~Our financial results are also likely to fluctuate due to factors that impact our current and prospective customers. Expenditures by customers tend to vary in cycles that reflect overall economic conditions, individual budgeting and buying patterns and, in some cases, the ability of ~~Contents~~some of our customers to obtain the financing they require to make capital expenditures. Our business has been harmed by a soft economy, and we would be further harmed by a decline in the economic prospects of our customers or the

Also, purchase decisions regarding our new Orion and Beamer products and applications may be made by individuals within organizations with which we have no significant existing relationships, such as customer service or sales and marketing departments. We may not be successful in developing the relationships necessary to sell our Orion and Beamer products and applications. 24

~~Our~~economy ~~revenues~~in ~~are~~general. ~~highly~~This harm would be ~~concentrated~~exacerbated ~~among~~by a ~~small~~decline ~~number~~in the economic prospects of our current and prospective customers in Europe, as revenues from this region have historically represented the majority of our total revenues. In many cases, these adverse economic conditions have altered current and prospective customers’ capital spending priorities or budget cycles, which have extended our sales cycle. These adverse effects could continue and could impact our customers’ ability to meet their financial obligations to us. Our business also could be harmed by changes in customer spending patterns reflecting industry trends. For example, customer budgetary constraints have contributed to downward sales price pressure on some of our products and on renewals of product support agreements for our Unified Assurance products, which have adversely affected our revenues. In addition, our financial results historically have been influenced by seasonal fluctuations, with orders tending to be strongest in the fourth quarter of each year and orders in our first quarter tending to be lower than the levels achieved in the preceding quarter. We believe that this seasonality has been due in large part to the capital appropriation practices of many of our customers.

~~A large~~As ~~percentage of our revenues are typically derived from~~ a ~~small~~result ~~number~~of all of ~~customers, and we expect this trend to continue. For example, in~~ the ~~nine months ended September 30~~foregoing, ~~2003,~~we ~~approximately~~cannot ~~72%~~assure ofyou that our revenues ~~were~~will ~~derived~~grow ~~from the ten~~or ~~largest~~remain ~~customers~~stable in ~~the~~future ~~period,~~periods ~~with~~or ~~one~~that ~~international~~we ~~customer~~will ~~accounting~~remain ~~for approximately 22%~~profitable. ~~Additionally,~~In ~~British Telecom and Deutsche Telekom~~addition, ~~on a combined basis, accounted for approximately 31% of total revenues in the nine months ended~~ September 30, 2003. Although the customer make-up of our largest projects varies from quarter to quarter, a small number of significant repeat customers frequently account for a significant portion of our revenues in asome ~~given~~future ~~period.~~quarters ~~If we lose one of~~ our ~~significant repeat customers, our~~ financial results ~~could~~may be ~~harmed.~~below ~~Additionally,~~the ifexpectations ~~one or more~~ of public ~~these~~market ~~significant~~analysts ~~repeat~~or ~~customers~~investors. ~~experiences~~In ~~adverse~~such ~~conditions in its industry or operations~~event, ~~including~~ the ~~continued~~market ~~impact~~price of ~~the~~our ~~current~~common ~~economic~~stock ~~downturn~~would ~~and~~likely ~~reductions in communications spending, these customers may not be able to meet their ongoing financial obligations to us or purchase additional products~~fall.

~~Changes~~Reduced communications spending, or ~~delays~~consolidations ~~in the implementation~~ or ~~customer~~bankruptcies ~~acceptance~~in ofthe ~~our~~communications industry, ~~products~~ could harm our business, financial condition and results. of operations.

~~Revenues~~We ~~for~~have derived ~~our~~substantially ~~Unified~~all ~~Assurance~~of ~~Solution~~our ~~products, which~~revenues ~~accounted~~from ~~for~~sales ~~the majority~~ of ~~our~~products ~~total~~and ~~revenues~~related services into the ~~nine~~communications ~~months~~industry. ~~ended~~Since ~~September~~early 302001, ~~2003,~~we ~~are~~and ~~typically~~a ~~recognized~~number ~~upon the completion~~ of ~~system~~other companies ~~installation~~have orbeen ~~customer~~impacted ~~acceptance.~~by ~~Delays~~reduced ~~caused~~spending by uscommunications orcarriers ~~our customers in the commencement~~and orequipment ~~completion~~manufacturers, ~~of scheduled product installations~~ and ~~acceptance~~spending ~~testing~~levels ~~may~~for ~~occur~~future ~~from~~periods ~~time~~are difficult to ~~time~~predict. Our ~~due to site-readiness delays~~business, ~~the~~financial condition ~~often comprehensive processes for testing~~ and ~~acceptance~~results ~~required~~of byoperations ~~certain~~could ofbe ~~our~~materially ~~customers,~~harmed ~~insufficient personnel~~in on the ~~part~~event that ofeconomic us or ~~our~~business ~~customers~~conditions toin ~~complete~~our aindustry ~~project,~~do ~~the~~not ~~lengthening~~continue ~~of implementation schedules due~~ to improve. ~~the~~We ~~introduction~~could ofalso ~~new~~be ~~features~~impacted orin ~~applications,~~the orevent ~~other~~that ~~issues.~~there ~~Because~~are ~~a significant portion~~ consolidations of our ~~revenues~~current oncustomers, awhich ~~quarterly basis~~could isresult ~~derived~~in ~~from~~the adisplacement ~~small number~~ of ~~customer projects, product installation delays could materially harm~~ our products ~~financial~~by ~~results for~~ a ~~particular~~competitor’s ~~period.~~products ~~With~~preferred ~~respect~~by tothe ~~contracts~~other ~~providing~~party ~~for~~to ~~a significant payment or performance milestone tied~~the toconsolidation, ~~customer acceptance~~ or ~~allowing~~bankruptcies ~~customer~~of ~~return,~~our ~~termination~~current or ~~similar~~prospective ~~rights prior to acceptance~~customers, wewhich could ~~generally~~result doin ~~not~~reduced ~~recognize~~revenues ~~revenue~~or ~~until~~significant ~~acceptance~~write-offs isof ~~achieved~~uncollectible accounts receivable. ~~For new products~~Additionally, wedecreases ~~typically~~in ~~recognize~~spending ~~revenue~~often ~~initially~~cause ~~upon~~delays ~~acceptance. As~~in asales ~~result,~~and ininstallations ~~cases~~and ~~where~~could ~~the~~cause ~~recognition~~cancellations of ~~revenue~~current isor ~~tied to customer acceptance~~planned projects, ~~the~~any ~~failure~~of towhich ~~obtain acceptance or delayed acceptance~~ could harm our financial results ~~for~~in a particular period. ~~Additionally, we may be subject to penalties or other customer claims for a failure to meet contractually agreed upon milestones or deadlines.~~

~~The~~Our financial ~~sales~~results ~~cycle~~could be materially harmed if demand for our new products is less ~~long,~~than ~~which~~we ~~could~~anticipate ~~harm~~or the performance of our ~~quarterly~~products ~~financial~~falls ~~results.~~below the levels required by our customers.

~~Sales~~A key component of our ~~Unified~~strategy ~~Assurance~~is ~~Solution products, which since 1998 have accounted for~~ the ~~majority~~ability ofto ~~our~~successfully ~~total revenues~~develop, ~~are~~introduce ~~made~~and market ~~predominantly~~new toUnified ~~large communications~~Assurance ~~carriers~~ and ~~involve~~Diagnostics ~~significant~~products ~~capital expenditures as well as lengthy sales cycles~~ and ~~implementation processes~~applications. Although ~~Sales~~we tohave ~~this~~obtained ~~type~~input offrom ~~customer~~our ~~generally~~customers ~~require~~and anpotential ~~extensive~~customers regarding ~~sales~~our ~~effort~~development ~~throughout the customer’s organization~~ and ~~final~~product ~~approval~~strategy, bywe anhave ~~executive~~made ~~officer~~certain assumptions oras ~~other~~to ~~senior-level~~the ~~approval.~~needs Weof ~~expend~~our ~~substantial~~customers ~~funds~~ and ~~management~~the ~~effort pursuing these sales. Additionally~~features, ~~potential~~functionality ~~customers~~and performance ~~often~~expected ~~maintain~~by ~~comprehensive~~them. ~~processes~~Our ~~for~~current ~~internal~~or ~~approval, contracting~~prospective ~~and~~customers ~~procurement, which~~ may ~~cause~~not order ~~potential~~these ~~sales~~new toproducts beand applications.

~~Page~~Also, 25purchase decisions regarding certain of 35our Unified Assurance products and applications may be influenced or made by individuals within organizations with which we have no significant existing relationships, such as customer service, sales and marketing, or information technology departments. We may not be successful in developing the relationships necessary to sell certain of our Unified Assurance products and applications.

~~Table~~In addition to the service quality management features of ~~Contents~~our Unified Assurance products, communications carriers also require systems to manage the quality of service of the other aspects of their

delayed or foregone. As a result of these and other factors, the sales cycle for our products is long, historically ranging from six to 18 months for our Unified Assurance Solution (excluding the cycle for subsequent applications and enhancements, which varies widely) and averaging three months for occasional, large sales of our Diagnostics products. Accordingly, our ability to forecast the timing and amount of specific sales is limited, and the deferral or loss of one or more significant sales could materially harm our financial results in a particular quarter, especially if there are significant sales and marketing expenses associated with any deferred or lost sales. 25

~~Competition~~customer-related ~~is intense~~activities, ~~may~~such as billing, ~~intensify~~trouble ticket management and ~~could~~inventory control. As a result, in ~~increased~~certain ~~downward~~cases ~~pricing~~a ~~pressure~~communications carrier may seek the functionality that we offer as a component of a broader service quality management system, ~~further~~addressing ~~reduced~~all ~~margins~~of these quality management needs, rather than through specific offerings from multiple vendors. In such cases, and as a result of the complexity ~~loss~~surrounding the integration of ~~market~~these ~~share~~various functionalities, the opportunity to provide these systems may only be offered to our competitors who have a broader product offering or to system integrators who would develop such functionality internally or purchase it from other vendors. We cannot assure you that we would be considered by such system integrators to provide our products as part of the overall service quality management system.

~~Competition for all of our products is intense, is expected to continue and in some cases may intensify. We compete principally with a number of U.S. and~~Our ~~international~~revenues ~~suppliers~~are ~~that~~highly ~~vary~~concentrated inamong ~~size and in the scope and breadth of the products and services offered. We compete to~~ a ~~lesser~~small ~~extent~~number ~~with systems developed internally by current and prospective customers. Certain~~ of ~~our competitors have, in relation to us, longer operating histories, larger installed customer bases, longer-standing relationships with~~ customers~~, greater name recognition and significantly greater financial, technical, marketing, customer service, public relations, distribution and other resources~~. As a result, these competitors may be able to more quickly develop or adapt to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, promotion and sale of their products. Additionally, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. Increased competition could result in increased downward pricing pressure, further reduced margins and the loss of market share. We continue to experience pressure on sales prices for our GeoProbe and Orion products, especially for those applications for which there is a competitive offering, or in highly competitive situations involving prospective customers.

~~Our~~A ~~business~~large percentage ~~depends~~of onour ~~retaining~~revenues are typically derived from a small number of customers, and we expect this trend to continue. For example, in the three months ended March 31, 2004, approximately 73% of our ~~existing~~revenues ~~key~~were derived ~~personnel~~from our 10 largest customers in the period, with four customers each accounting for more than 10% of total revenues. On a combined basis, our four 10% customers in this three-month period accounted for approximately 54% of our total revenues. Although the customer make-up of our largest projects varies from quarter to quarter, a small number of significant repeat customers frequently account for a significant portion of our revenues in a given period. If we were to lose one or more of our significant repeat customers, our financial results could be harmed. Additionally, if one or more of these significant repeat customers experiences adverse conditions in its industry or operations, including the impact of any economic downturn or reduction in communications spending, these customers may not be able to meet their ongoing financial obligations to us or purchase additional products.

~~Our business depends to a~~Changes ~~significant~~or ~~extent~~delays ~~upon~~in the ~~continued~~implementation ~~service~~or ~~and~~customer ~~performance~~acceptance of ~~a relatively small number of key senior managers, technical personnel and sales and marketing personnel, none of whom are bound by an agreement to remain in~~ our ~~employ.~~products ~~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~~.

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

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

•Sales ~~develop~~of ~~and~~our Unified ~~introduce~~Assurance ~~new~~ products, orwhich ~~applications~~since 1998 have accounted for the majority of our total revenues, are made predominantly to large communications ~~market;~~carriers and involve significant capital expenditures as well as lengthy sales cycles and implementation processes. Sales to this type of customer generally require an extensive sales effort throughout the customer’s organization and final approval by

~~• enhance our Unified Assurance Solution and Diagnostics products;~~26

•an ~~keep~~executive ~~pace~~officer ~~with~~or ~~evolving~~other ~~industry~~senior-level approval. ~~protocol~~We ~~standards~~expend substantial funds and management effort pursuing these sales. Additionally, ~~next-generation~~potential ~~technologies~~customers often maintain comprehensive processes for internal approval, contracting and ~~changing~~procurement, ~~customer~~which ~~needs;~~may cause potential sales to be delayed or foregone. As a result of these and other factors, the sales cycle for our products is long, historically ranging from six to 18 months for our Unified Assurance products (excluding the cycle for subsequent applications and enhancements, which varies widely) and averaging three months for occasional, large sales of our Diagnostics products. Accordingly, our ability to forecast the timing and amount of specific sales is limited, and the deferral or loss of one or more significant sales could materially harm our financial results in a particular quarter, especially if there are significant sales and marketing expenses associated with any deferred or lost sales.

•Competition is ~~achieve~~intense, ~~broad~~may ~~market~~intensify ~~acceptance~~and ~~for~~could ~~our~~result ~~products~~in increased downward pricing pressure, reduced margins and the loss of market share.

Competition for all of our products is intense, is expected to continue and in some cases may intensify. We ~~cannot~~compete ~~assure~~principally ~~you~~with a number of U.S. and international hardware and software suppliers that wevary ~~will~~in ~~achieve~~size and in the scope and breadth of the products and services offered. We compete to a lesser extent with systems integrators and with the international 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 other resources. As a result, these ~~objectives~~competitors may be able to more quickly develop or adapt to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, promotion and sale of their products. Additionally, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. Increased competition could result in increased downward pricing pressure, reduced margins and the loss of market share. We continue to experience pressure on sales prices for our most basic GeoProbe system and certain of our Orion applications, especially for those applications for which there is a competitive offering, or in highly competitive situations involving prospective customers.

~~Page~~Our business 26depends ofon 35retaining our existing key personnel.

~~Table~~Our business depends to a significant extent upon the continued service and performance of ~~Contents~~a relatively small number of key senior managers, technical personnel and sales and marketing personnel, few of whom are bound by an agreement to remain in our employ. The loss of any existing key personnel, or the inability to attract, motivate and retain additional key personnel, could harm our business, financial condition and results of operations.

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

~~Products as complex as~~The ~~those~~introduction ~~currently under development~~ by usothers ~~frequently are subject to delays, and we cannot assure you that we will not encounter difficulties, such as the inability to assign a sufficient number~~ of ~~qualified~~products ~~technical~~involving ~~personnel~~superior totechnologies ~~key projects~~ or ~~other~~the ~~unanticipated~~evolution ~~causes,~~of ~~that~~alternative ~~could~~technologies ~~delay~~ or ~~prevent~~new ~~the~~industry ~~successful~~protocol ~~and~~standards ~~timely~~could render ~~development,~~our ~~introduction~~existing ~~and marketing of these potential new~~ products., ~~Even~~as ifwell ~~such~~as ~~potential new~~ products ~~are~~currently ~~developed~~under ~~and introduced~~development, ~~we cannot assure you that they~~ ~~will~~obsolete ~~achieve any significant degree of market acceptance. In addition, our products are implemented with our purpose-specific hardware platform~~ and ~~certain third-party hardware~~unsalable. We ~~cannot~~believe ~~assure~~that ~~you~~our ~~that~~future wesuccess will bedepend ~~able~~in topart upon ~~design~~our ~~and manufacture~~ability, ~~or procure~~on ~~from~~a ~~third~~timely ~~parties,~~and ~~the~~cost-effective ~~hardware~~basis, ~~necessary~~ to ~~successfully~~continue ~~implement our new products and applications.~~ to:

~~A majority of our revenues have historically come from our international customers,~~ • develop and, asintroduce anew ~~result,~~products ~~our~~or ~~business~~applications ~~may~~for ~~be harmed by political and economic conditions in foreign markets and~~ the ~~challenges~~communications ~~associated with operating internationally.~~ market;

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

• keep pace ~~management~~with ofevolving ~~our~~industry ~~geographically~~protocol ~~dispersed~~standards, ~~operations~~next-generation technologies and changing customer needs;

~~• longer sales cycles in certain countries, especially on initial entry into a new geographical market;~~27

• establish and ~~greater~~maintain ~~difficulty~~interoperability inbetween ~~evaluating~~our aproducts ~~customer’s~~and ~~ability~~the tothird-party ~~pay,~~products forming ~~longer~~other ~~accounts~~components ~~receivable~~of ~~payment~~our ~~cycles~~customers’ ~~and~~operation ~~greater~~support ~~difficulty in the collection of past-due accounts~~systems; and

• achieve broad ~~general~~market ~~economic~~acceptance ~~conditions~~for inour ~~each country;~~products.

•We ~~currency~~cannot assure ~~controls~~you ~~and~~that ~~exchange~~we ~~rate~~will ~~fluctuations;~~achieve these objectives.

•Over ~~challenges~~the ~~associated~~long term, ~~with~~we ~~operating~~expect incarrier ~~diverse~~spending ~~cultural~~for traditional networks to continue to decrease, which requires that we continue to develop products and ~~legal~~applications for ~~environments;~~networks based on emerging next-generation wireless and packet-based technologies and standards. We may not successfully develop or acquire additional competitive products for these emerging technologies and standards.

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

•A majority ~~loss~~ of our revenues, ~~property~~have ~~and~~historically ~~equipment~~come from ~~expropriation,~~our ~~nationalization~~international customers, ~~war~~and, ~~insurrection~~as a result, ~~terrorism~~our ~~and~~business ~~other~~may be harmed by political ~~risks;~~and economic conditions in foreign markets and the challenges associated with operating internationally.

•Historically, revenues ~~foreign~~from ~~taxes~~international ~~and~~markets have represented the ~~overlap~~majority of ~~different~~our ~~tax structures~~total revenues, ~~including~~and ~~modifications~~international torevenues ~~the~~as Ua percentage of total revenues have increased in recent years.S. ~~tax~~We ~~code~~expect asrevenues afrom ~~result~~international markets to continue to represent the majority of ~~international~~our ~~trade~~total ~~regulations;~~revenues for the foreseeable future. International business activities involve certain risks, including:

• management of ~~greater~~our ~~difficulty~~geographically indispersed ~~safeguarding intellectual property~~operations;

• longer sales ~~import~~cycles ~~and~~in ~~export~~certain ~~licensing~~countries, ~~requirements~~especially ~~and~~on ~~other~~initial ~~trade~~entry ~~restrictions~~into a new geographical market;

• greater difficulty ~~involuntary~~in ~~renegotiation~~evaluating ofa ~~contracts~~customer’s ~~with~~ability ~~foreign~~to ~~governments~~pay, ~~and~~longer ~~communications~~accounts ~~carriers;~~receivable payment cycles and greater difficulty in the collection of past-due accounts;

• ~~existence or adoption of laws and regulations affecting the operation and taxation of our business and the~~ general economic ~~business~~conditions ~~climate~~in ~~for~~each ~~foreign companies.~~country;

~~Page~~• currency controls 27and ofexchange 35rate fluctuations;

~~Table~~• challenges associated ofwith ~~Contents~~operating in diverse cultural and legal environments;

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

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

~~Key components used in our products may become obsolete. If we are unable to find and design in replacement parts, we may be unable to ship our products in sufficient quantities.~~ 28

~~From~~• foreign taxes ~~time to time, components used in our products are declared obsolete~~ and no ~~longer~~the ~~produced~~overlap byof ~~our~~different ~~suppliers.~~tax ~~Historically~~structures, weincluding ~~have~~modifications ~~typically received adequate notice from these suppliers so that we may procure quantities of these parts sufficient~~ to ~~allow us time to find and design new parts into our products; however,~~ wethe ~~cannot assure you that we will always be provided adequate notice~~U. ~~If we are not given adequate notice, we may be unable to produce sufficient quantities of our products to satisfy demand~~S. ~~Also,~~tax wecode ~~cannot~~as ~~assure you that replacement parts will be readily available or that we will be able to design new parts into our products on~~ a ~~timely~~result ~~basis at a reasonable cost. If we are not able to produce sufficient quantities~~ of ~~our~~international ~~products,~~trade ~~our financial results could be harmed.~~ regulations;

~~Page~~• greater difficulty 28in ofsafeguarding 35intellectual property;

~~Table~~• import and ofexport ~~Contents~~licensing requirements and other trade restrictions;

~~Our~~• involuntary renegotiation ~~inventory~~of ~~may~~contracts ~~become~~with ~~obsolete~~foreign orgovernments ~~unusable.~~and communications carriers; and

~~From~~• existence or ~~time~~adoption ~~to time, we make advance purchases~~ of ~~various~~laws ~~component~~and ~~parts~~regulations ~~in relatively~~affecting ~~large~~the ~~quantities~~operation ~~to ensure that we have an adequate~~ and ~~readily~~taxation ~~available~~of ~~supply. Our failure to accurately project~~ our business ~~needs for these components~~ and the ~~demand~~general ~~for our products that incorporate them, or changes in our~~ business ~~strategy that~~climate ~~reduce our need~~ for ~~these~~foreign ~~components, could result in these components becoming obsolete prior to their intended use or otherwise unusable in our business, which in turn could result in significant write-offs of inventory~~companies.

We may ~~rely~~be inunable ~~part~~to onproduce ~~third-party~~sufficient ~~subcontractors~~quantities inof ~~the~~our ~~manufacture~~products ~~and~~because we ~~development~~obtain ofvarious ~~our~~key ~~products~~components from sole and limited source suppliers. ~~Our~~If ~~ability~~we are unable to ~~sell~~obtain ~~products~~these tocomponents, ~~our~~or ~~customers~~if the prices of these components increase, we could be ~~impaired~~unable ifto ~~these~~ship ~~subcontractors~~our doproducts ~~not~~in ~~meet~~a ~~their~~timely ~~commitments~~manner toor ~~us.~~our product costs could be materially impacted.

~~Any~~We ~~disruption~~could experience delays or reductions in ~~our~~product ~~relationships~~shipments ~~with~~or ~~third-party~~increases ~~subcontractors~~in ~~and~~product costs ~~our~~if ~~inability~~we are unable to obtain sufficient key components as required or to develop alternative sources if and as required in the future. ~~could~~Currently, ~~result~~our products inutilize ~~delays~~certain orcomponents ~~reductions~~that inare ~~product~~available ~~shipments~~from only one or ~~increases~~a limited innumber ~~product~~of ~~costs~~suppliers. WeWhile ~~rely~~alternative ~~exclusively~~suppliers ~~upon~~have ~~third-party~~been ~~subcontractors~~identified for toa ~~manufacture~~variety ~~our~~of ~~subassemblies~~key components, ~~and~~those wealternative sources have ~~retained~~not been qualified or activated by us. Our qualification process could be lengthy, ~~from~~and we ~~time~~cannot assure you that additional sources would become available to ~~time~~us on a timely basis, or if such sources were to become available, that the components ~~third-party~~would ~~design~~be ~~services~~comparable in ~~the~~price ~~layout~~and ofquality ~~circuit~~to ~~boards~~our current components. We generally ~~also~~do ~~frequently~~not ~~subcontract~~execute long-term supply agreements with our suppliers and, in the ~~development~~case of ~~specific~~many ~~features~~components, ormake ~~enhancements~~our ~~for~~purchases with purchase orders on an “as-needed basis.” Some of the components our products utilize require long order lead-times, in certain cases up to nine months. Other components that currently are readily available may become difficult to obtain in the future. Our ~~reliance~~failure onto ~~third-party~~order ~~subcontractors~~sufficient ~~involves~~quantities aof ~~number~~these components in advance of product ~~risks,~~delivery ~~including~~deadlines could prevent us from adequately responding to unanticipated increases in customer orders. In the past, we have experienced ~~potential~~delays ~~absence~~in the receipt of ~~adequate~~a ~~capacity~~variety of our key components, which have resulted in delays in product deliveries. In addition, the ~~unavailability~~cost of orvarious ~~interruption~~key components of our products has fluctuated significantly in ~~access~~the topast ~~various~~based ~~process~~on supply ~~technologies,~~and demand factors. Significant changes in supply and ~~reduced~~demand characteristics ~~control~~in ~~over~~the ~~product~~future ~~quality,~~could ~~delivery~~cause ~~schedules~~the cost of various components to increase, ~~manufacturing~~which ~~yields~~could ~~and~~adversely impact our product costs.

WeKey components ~~rely~~used ~~upon~~in ~~software~~our ~~licensed~~products ~~from~~may ~~third~~become ~~parties~~obsolete. If we are unable to ~~maintain~~ ~~these~~find ~~software~~and design ~~licenses~~in onreplacement ~~commercially reasonable terms~~parts, ~~our~~we ~~business,~~may ~~financial~~be ~~condition~~unable ~~and~~to ~~results~~ship ofour ~~operations~~products ~~could~~in sufficient ~~be harmed~~quantities.

WeFrom ~~rely~~time ~~upon~~to time, ~~software~~components ~~that~~used wein ~~license~~our ~~from~~products ~~Oracle~~are ~~Corporation,~~declared ~~Cognos~~obsolete ~~Incorporated~~ and ~~other~~no ~~third~~longer produced ~~parties,~~by ~~including~~our ~~software~~suppliers. ~~that~~Historically, iswe ~~integrated~~have ~~with~~typically ~~our~~received adequate ~~internally-developed~~notice ~~software~~from ~~and~~these ~~used~~suppliers inso ~~our~~that ~~products~~we tomay ~~perform~~procure ~~key~~quantities ~~functions.~~of Inthese ~~certain~~parts sufficient ~~cases,~~to weallow ~~are~~us ~~unable~~time to ~~obtain~~find ~~long-term~~and ~~pricing~~design ~~commitments~~new ~~for~~parts ~~this~~into ~~software.~~our ~~The~~products; however, ~~inability~~we tocannot ~~maintain~~assure ~~any~~you ~~software~~that ~~licenses~~we onwill ~~commercially~~always ~~reasonable terms~~be ~~could~~provided ~~result~~adequate innotice. If ~~shipment~~we ~~delays~~are ornot ~~reductions~~given ~~until~~adequate ~~equivalent~~notice, ~~software~~we ~~could~~may be ~~developed~~unable orto ~~licensed~~produce ~~and~~sufficient quantities ~~integrated~~of ~~into~~ our products to satisfy demand. ~~Additionally~~Also, ~~the~~we ~~presence~~cannot ofassure ~~defects~~you orthat replacement ~~errors~~parts inwill ~~this~~be ~~software~~readily ~~could~~available ~~result~~or inthat ~~claims~~we ~~against~~will usbe ~~or damage~~able to design new parts into our ~~reputation~~products ~~and~~on ~~business,~~a ~~recourse~~timely ~~for~~basis ~~which~~at ~~might~~a reasonable cost. If we are not beable ~~available~~to ~~against~~produce ~~the~~sufficient ~~related~~quantities ~~licensors.~~of our products, our financial results could be harmed.

~~We may not receive the intended benefits of future acquisitions, joint ventures or other business relationships.~~ 29

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

~~Page~~From 29time to time, we make advance purchases of 35various component parts in relatively large quantities to ensure that we have an adequate and readily available supply. Our failure to accurately project our needs for these components and the demand for our products that incorporate them, or changes in our business strategy that reduce our need for these components, could result in these components becoming obsolete prior to their intended use or otherwise unusable in our business, which in turn could result in significant write-offs of inventory.

~~Table~~We rely in part on third-party subcontractors in the manufacture and development of ~~Contents~~our products. Our ability to sell products to our customers could be impaired if these subcontractors do not meet their commitments to us.

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

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

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

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

WeAlthough in the past we have developed or licensed substantially all of our product technologies, some of the technologies, features and functionalities we are contemplating or which may ~~face~~be required to meet the perceived needs of our customers and potential ~~liability~~customers ~~for~~may ~~product~~be ~~defects~~more effectively and timely obtained through the acquisition of businesses, products or technologies from third-parties, or the establishment of joint venture, strategic partnership or other arrangements with firms already possessing such technologies. We may also pursue such acquisitions or arrangements to expand our business, addressable markets and product offerings. There can be no assurance that suitable and interested candidates for these activities will be identified, or if they are identified that any such acquisition or arrangement can be consummated on terms acceptable to us.

Products as complex as ours may contain undetected defects or errors, especially when first introduced or as enhancements are released, that, despite our testing, are not discovered until after a product has been installed and used by customers. Defects or errors could result in delayed market acceptance of the product, claims against us or damage to our reputation and business. We generally include provisions in our agreements with customers that are intended to limit our exposure to potential liability for damages arising out of defects or errors in our products. However, the nature and extent of these limitations vary from agreement to agreement, and it is possible that these limitations may not be effective as a result of unfavorable judicial decisions or current or future laws enacted in one or more of the jurisdictions in which we do business. Although we have not experienced any product liability suits to date, the sale and support of our products entail the risk of these claims. We carry insurance that mitigates our risk associated with certain product liability claims, but the policy is subject to coverage limits, various exceptions and options to cancel prior to term and may not be sufficient to cover all claims. Any product liability claim brought against us, regardless of its merit, could result in material expense to us, diversion of management attention and resources, and damage to our business reputation and our ability to retain existing customers or attract new customers. 30

~~Page~~The negotiation 30of potential acquisitions or strategic relationships, as well as the integration of 35an acquired or jointly developed business, technology or product, could cause diversion of management’s time and resources. Future acquisitions and strategic relationships by us could result in potentially dilutive issuances of equity securities, a material reduction in cash reserves, the incurrence of debt and contingent liabilities, research and development write-offs and other acquisition-related expenses. We cannot assure you that any acquisition or joint venture will be successfully integrated with our operations. If we were to pursue any such acquisition or strategic relationship, we may not receive the intended benefits of the acquisition or strategic relationship.

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

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

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

Our ~~two~~continued success ~~largest~~is ~~stockholders~~dependent ~~own~~in ~~approximately~~part ~~40%~~upon ofour proprietary technology. To protect our proprietary ~~common~~technology, ~~stock~~we rely on a combination of technical innovation, trade secret, copyright and trademark laws, non-disclosure agreements and, to a lesser extent, patents, each of which ~~gives~~affords ~~them~~only ~~substantial~~limited ~~control~~protection. ~~over~~In addition, the ~~management~~laws of some foreign countries do not protect our proprietary rights in our products to the same extent as do the laws of the U.S. Despite the measures taken by us, it may be possible for a third party to copy or otherwise obtain and ~~affairs~~use our proprietary technology and information without authorization. Policing unauthorized use of our ~~company~~products is difficult, and litigation may be necessary in the future to enforce our intellectual property rights. Any litigation could ~~delay~~be time consuming and expensive to prosecute or resolve, ~~prevent~~result ain ~~change~~substantial diversion of ~~control~~management attention and resources, and materially harm our business, financial condition and results of operations. We may not be successful in protecting our proprietary technology, or our proprietary rights may not provide us a meaningful competitive advantage.

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

WeProducts ~~have~~as complex ~~previously~~as ~~adopted~~ours ~~anti-takeover~~may ~~defenses~~contain undetected defects or errors, especially when first introduced or as enhancements are released, that, despite our testing, are not discovered until after a product has been installed and used by customers. Defects or errors could ~~delay~~result in delayed market acceptance of the product, claims against us or damage to our reputation and business. We generally ~~prevent~~include anprovisions ~~acquisition~~in our agreements with customers that are intended to limit our exposure to potential liability for damages arising out of defects or errors in our ~~company~~products. However, the nature and extent of these limitations vary from agreement to agreement, and it is possible that these limitations may not be effective as a result of unfavorable judicial decisions or current or future laws enacted in one or more of

Our certificate of incorporation and bylaws and Delaware law contain provisions that may have the effect of discouraging, delaying or preventing a change in control of our company or unsolicited acquisition proposals that a stockholder may consider favorable. For example, we have a classified board of directors with staggered, three-year terms, our stockholders are unable to take action by written consent, our stockholders are limited in their ability to make proposals at stockholder meetings, and our board of directors is empowered to issue blank-check preferred stock without any need to obtain stockholder approval. 31

~~Volatility~~the jurisdictions in which we do business. Although we have not experienced any product liability suits to date, the sale and support of our ~~stock~~products ~~price~~entail the risk of these claims. We carry insurance that mitigates our risk associated with certain product liability claims, but the policy is subject to coverage limits, various exceptions and options to cancel prior to term and may not be sufficient to cover all claims. Any product liability claim brought against us, regardless of its merit, could result in material ~~claims~~expense ~~against~~to us., diversion of management attention and resources, and damage to our business reputation and our ability to retain existing customers or attract new customers.

~~The~~Our business ~~market price of our common stock has been,~~ and isreputation ~~likely~~could tosuffer ~~continue~~if towe ~~be,~~do ~~highly~~not ~~volatile.~~prevent Insecurity ~~the periods listed below, the market price of our common stock has ranged as follows:~~ breaches.

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

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

~~Page~~Our two 31largest stockholders own approximately 39% of 35our common stock, which gives them effective control over the management and affairs of our company and could delay or prevent a change of control.

~~Table~~Two of ~~Contents~~our founders, Samuel S. Simonian, chairman of our board, and Elie S. Akilian, our president and chief executive officer and a director, collectively beneficially own approximately 39% of the outstanding shares of our common stock. Consequently, if these individuals were to act together, they could effectively control the outcome of all matters submitted for stockholder action, including the election of our board of directors and the approval of significant corporate transactions. They also effectively control the management and affairs of our company, which could have the effect of delaying or preventing a change in control of our company. In addition, as two of the five members of our board of directors, Messrs. Simonian and Akilian have significant influence in directing the actions taken by our board.

~~Our~~We have ~~stock~~previously ~~price~~adopted ~~may~~anti-takeover bedefenses ~~significantly~~that ~~affected~~could bydelay ~~factors~~or ~~such~~prevent ~~as:~~an acquisition of our company.

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

~~• changes in our business strategy;~~32

•Volatility in ~~future sales of~~ our ~~common~~ stock, ~~particularly~~price bycould ~~institutional~~result ~~investors~~in ~~with~~claims ~~large~~against ~~holdings and by our founders;~~us.

•The ~~the~~market price ~~announcement~~ of ~~technological~~our ~~innovations~~common orstock ~~new~~has ~~products~~been, byand usis likely to continue to be, highly volatile. In the periods listed below, the market price of our ~~competitors~~common orstock ~~others;~~has ranged as follows:

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

	High		Low
2004
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 ~~the~~stock ~~financial~~price ~~and~~may ~~other~~be ~~announcements~~significantly ~~made~~ affected by ~~us,~~factors ~~our~~such ~~competitors or customers;~~as:

• variations in ~~general~~our ~~market~~results ~~and~~of ~~economic conditions~~operations; ~~and~~

• changes in ~~equity~~our ~~market~~business ~~conditions and industry-specific equity market trends.~~strategy;

~~The public markets have experienced significant volatility that has particularly affected the market prices of securities of many technology and~~• future ~~communications~~sales ~~companies for reasons that have often been unrelated to financial results. This volatility has and may continue to materially harm the market price~~ of our common stock, asparticularly ~~well~~by asinstitutional ~~our~~investors ~~visibility~~with large holdings and ~~credibility~~by in our ~~markets.~~ founders;

~~Additionally, in~~ • the ~~past, securities class action litigation~~ ~~often~~announcement ~~has been brought against a company following periods~~ of ~~volatility~~technological ininnovations ~~the~~or ~~market~~new ~~price~~products ofby ~~its~~us, ~~common stock. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and diversion of~~our ~~management~~competitors ~~attention~~or ~~and resources.~~ others;

• market ~~Item~~analysts’ 3.estimates ~~Quantitative~~of ~~and~~our ~~Qualitative~~performance, ~~Disclosures~~our ~~about~~customers’ ~~Market~~or ~~Risk~~competitors’ performance or the performance of the communications industry in general;

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

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

~~Our international business is subject to the typical risks of any~~• equity ~~international~~market ~~business,~~conditions ~~including, but not limited to, the risks described in Item 2—“Management’s Discussion~~ and ~~Analysis~~industry-specific ofequity ~~Financial~~market ~~Condition and Results of Operations—Risk Factors~~trends.~~” Accordingly, our future results could be materially harmed by the actual occurrence of any of these or other risks.~~

~~Page~~The 32public markets have experienced significant volatility that has particularly affected the market prices of 35securities of many technology and communications companies for reasons that have often been unrelated to financial results. This volatility has and may in the future materially harm the market price of our common stock as well as our visibility and credibility in our markets.

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

~~Currently, our cash is invested in bank deposits and money market funds denominated in U.S. dollars. We~~Item ~~account for these investments in accordance with SFAS 115, Accounting for Certain Investments in Debt and Equity Securities~~3. ~~These cash equivalents are treated as available-for-sale under SFAS 115. The carrying value of these cash equivalents~~ Quantitative ~~approximates fair market value. Our investments are subject to interest rate risk, which is the risk that our financial condition~~ and ~~results~~Qualitative ofDisclosures ~~operations~~about ~~could~~Market be adversely affected due to movements in interest rates. Assuming current levels of cash, if the per annum rate of interest earned on our invested cash were to change by 50 basis points, or 0.5%, our investment income would be impacted by approximately $0.8 million on an annual basis. Risk

Historically, ~~Item~~we have been exposed to immaterial levels of market risk and have not been significantly exposed to fluctuations in currency exchange rates. In the three months ended March 31, 2004, approximately 4% of total revenues was denominated in currencies other than the U.S. ~~Controls~~dollar. In ~~and~~the ~~Procedures~~full-year 2003, approximately 3% of total revenues was denominated in currencies other than the U.S. dollar, principally the Euro. In future periods, we believe a greater portion of total revenues could be

(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in the periodic reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the rules of the SEC. We carried out an evaluation as of September 30, 2003, under the supervision and the participation of our management, including our chief executive officer and chief financial officer, of the design and operation of these disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the company (including our consolidated subsidiaries) required to be included in our periodic SEC filings.33

~~(b)~~denominated ~~Changes~~ in ~~internal~~currencies ~~controls~~other ~~over~~than ~~financial~~the ~~reporting~~U.S. dollar, ~~There~~thereby ~~was~~increasing noour ~~change~~exposure into ~~internal~~exchange ~~control~~rate ~~over~~gains ~~financial~~and ~~reporting~~losses ~~that~~on non-U.S. ~~occurred~~currency ~~during the three months ended September 30~~transactions. Currently, ~~2003~~we ~~that~~do ~~has~~not ~~materially~~engage ~~affected,~~in orhedging isactivities ~~reasonably~~for ~~likely to materially affect,~~ our ~~internal~~non-U.S. dollar ~~control over financial reporting~~business.

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

Our international business is subject to the typical risks of any international business, including, but not limited to, the risks described in Item 2. ~~Changes~~– in“Management’s ~~Securities~~Discussion and ~~Use~~Analysis of ~~Proceeds~~ Financial Condition and Results of Operations – Risk Factors.” Accordingly, our future results could be materially harmed by the actual occurrence of any of these or other risks.

~~The~~Currently, ~~Securities~~our ~~and~~cash ~~Exchange~~is ~~Commission~~invested onin ~~May~~bank ~~26,~~deposits ~~1999~~and ~~declared~~money ~~effective~~market ~~our~~funds denominated ~~registration~~in ~~statement~~U.S. ondollars. ~~Form~~We ~~S-1~~account ~~(File~~for ~~No.~~these ~~333-59753)~~investments ~~relating~~in toaccordance with ~~the~~SFAS ~~initial~~115, ~~public~~Accounting ~~offering~~for ofCertain ~~our~~Investments ~~common~~in ~~stock~~Debt and Equity Securities. These Ascash ofequivalents ~~September~~are ~~30, 2003,~~treated weas ~~have~~available-for-sale ~~used~~under ~~all~~SFAS 115. The carrying value of ~~the~~these ~~net~~cash ~~offering~~equivalents approximates ~~proceeds~~fair ~~for~~market ~~the~~value. We ~~purchase~~also invest ofin ~~temporary~~U.S. ~~investments~~Treasury bills, ~~consisting~~U.S. ofgovernment ~~cash,~~agency ~~cash~~discount ~~equivalents,~~notes and commercial ~~short-term investments~~paper. U.S. WeTreasury ~~currently~~bills, U.S. ~~intend~~government toagency ~~use~~discount ~~the~~notes ~~net~~and ~~proceeds~~commercial ofpaper ~~the~~with ~~offering~~maturities ~~for~~that are ~~working~~less ~~capital~~than ~~and general~~90 ~~corporate~~days ~~purposes,~~are ~~including~~classified ~~financing~~as ~~accounts~~cash ~~receivable~~equivalents. U.S ~~and~~Treasury ~~capital~~bills, ~~expenditures~~U.S. ~~made~~government inagency discount ~~the~~notes ~~ordinary~~and ~~course~~commercial ofpaper ~~business.~~with Wematurities ~~also~~that ~~may~~are ~~apply~~more athan ~~portion~~90 ofdays but ~~the~~less ~~proceeds~~than ofone ~~the~~year ~~offering~~are toclassified ~~acquire~~as ~~businesses,~~short-term ~~products~~investments. All ~~and~~U.S. ~~technologies~~Treasury bills, orU.S. government ~~enter~~agency ~~into~~discount ~~joint~~notes ~~venture~~and ~~arrangements,~~commercial ~~that~~paper are ~~complementary~~classified toas ~~our~~held ~~business~~to maturity and carried ~~product~~at ~~offerings;~~amortized ~~however,~~cost. Our atinvestments are ~~this~~subject ~~time~~to weinterest ~~have~~rate ~~not~~risk, ~~identified~~which ais ~~specific~~the ~~acquisition~~risk orthat ~~joint~~our ~~venture~~financial condition orand ~~allocated~~results aof ~~specific~~operations ~~amount~~could ~~for~~be ~~this~~adversely ~~purpose.~~affected Wedue ~~also may~~to ~~apply~~movements ain ~~portion~~interest ofrates. Assuming current ~~the~~levels ~~proceeds~~of tocash, if the ~~payment~~per annum rate of interest earned on our invested cash ~~dividends~~were orto ~~for~~change ~~additional~~by ~~stock~~50 ~~repurchases~~basis points, or ~~other~~0.5%, ~~similar~~our ~~transactions~~investment income would be impacted by approximately $0.4 million on an annual basis.

~~Page~~Item 334. Controls and ~~of 35~~ Procedures

~~Table~~(a) Evaluation of disclosure ~~Contents~~controls and procedures. We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in the periodic reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the rules of the SEC. We carried out an evaluation as of March 31, 2004, under the supervision and the participation of our management, including our chief executive officer and chief financial officer, of the design and operation of these disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the company (including our consolidated subsidiaries) required to be included in our periodic SEC filings.

(b) Changes in ~~Item~~internal 6control over financial reporting. ~~Exhibits~~There ~~and~~was ~~Reports~~no onchange ~~Form~~in ~~8-K~~our internal control over financial reporting that occurred during the three months ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

~~(a) Exhibits~~34

10.1		Amended and Restated Registration Rights Agreement dated September 30, 2003 by and among the registrant, Samuel S. Simonian and Elie S. Akilian
31.1		Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

PART II. OTHER INFORMATION

~~(b)~~Item ~~Reports~~2. Changes in onSecurities, ~~Form~~Use ~~8-K~~of Proceeds and Issuer Repurchases of Equity Securities

~~During~~The ~~the~~Securities ~~three~~and ~~months~~Exchange ~~ended~~Commission ~~September 30~~on May 26, ~~2003~~1999 wedeclared ~~filed~~effective aour ~~Current~~registration ~~Report~~statement on Form 8S-K1 (File onNo. ~~September~~333-59753) 18relating to the initial public offering of our common stock. As of March 31, ~~2003~~2004, we have used all of the net offering proceeds for the purchase of temporary investments, consisting of cash, cash equivalents, and short-term investments. We ~~The~~currently ~~report~~intend ~~included~~to ~~information~~use ~~reported~~the net proceeds ~~under~~of ~~Item~~the ~~5—Other~~offering ~~events~~for working capital and ~~Item~~general ~~7—Financial~~corporate ~~Statements~~purposes, ~~Pro~~including financing ~~Forma~~accounts ~~Financial~~receivable ~~Information~~and capital expenditures made in the ordinary course of business. We also may apply a portion of the proceeds of the offering to acquire businesses, products and technologies, ~~Exhibits~~or enter into joint venture arrangements, that are complementary to our business and product offerings; however, at this time we have not identified a specific acquisition or joint venture or allocated a specific amount for this purpose. We also may apply a portion of the proceeds to the payment of cash dividends or for additional stock repurchases or other similar transactions.

We did not repurchase any shares of our common stock ~~SIGNATURES~~during the three months ended March 31, 2004.

~~Pursuant to the requirements of the~~Item ~~Securities~~6. Exhibits and ~~Exchange~~Reports ~~Act of 1934, the registrant has duly caused this report to be signed~~ on ~~its~~Form ~~behalf~~8-K ~~by the undersigned 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)

(a)	Exhibits

	10.1	Employment Agreement dated June 27, 1990 between the registrant and Michael J. Reiman.
	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.

~~Date:~~(b) Reports on ~~October~~Form ~~21, 2003~~ 8-K

~~Page~~During the 34three ofmonths 35ended March 31, 2004 we furnished one Report on Form 8-K. Information regarding each item reported on is listed below.

Date Filed or Furnished		Item No.		Description
January 27, 2004		Item 12		On January 27, we announced our results of operations for our fiscal quarter and year ended December 31, 2003.*

~~INET~~*This furnished ~~TECHNOLOGIES,~~Form ~~INC.~~8-K is not to be deemed filed or incorporated by reference into any filing.

~~INDEX TO EXHIBITS~~ 35

Exhibit Number		Description
10.1		Amended and Restated Registration Rights Agreement dated September 30, 2003 by and among the registrant, Samuel S. Simonian and Elie S. Akilian
31.1		Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Elie S. Akilian, President and Chief Executive Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Jeffrey A. Kupp, Vice President and Chief Financial Officer of the Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

~~Page~~Pursuant 35to the requirements of 35the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	INET TECHNOLOGIES, INC.

	By:	/s/	Jeffrey A. Kupp
			Jeffrey A. Kupp
			Vice President and Chief Financial Officer (Principal accounting and financial officer)

Date: April 21, 2004

INET TECHNOLOGIES, INC.
INDEX TO EXHIBITS

Exhibit Number		Description

10.1		Employment Agreement dated June 27, 1990 between the registrant and Michael J. Reiman.
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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