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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2002

OR

THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-24707

INET TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(469) 330-4000

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value

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   ü   No       

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.  ¨

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

The aggregate market value of the voting stock held by non-affiliates of the registrant on June 28, 2002 was $87,161,319.

The number of shares of common stock outstanding of the registrant on February 27, 2003 was 38,361,704.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required by Part III of this Annual Report is incorporated by reference from the registrant’s definitive proxy statement to be delivered to stockholders in connection with the registrant’s 2003 Annual Meeting of Stockholders.

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INET TECHNOLOGIES, INC.

FORM 10-K

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PART I

Item 1. Business.

This Annual Report on Form 10-K 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:

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

Overview

Inet Technologies, Inc. is a leading global provider of communications software solutions that enable communications carriers to more strategically operate their businesses. Current offerings in our Unified Assurance^TM solution convert network information into valuable and actionable intelligence that carriers use to help ensure the health of their revenue-generating infrastructure. These real-time powered solutions help carriers realize organizational efficiencies in managing their operations. Our diagnostics solutions allow communications carriers and equipment manufacturers to quickly and cost-effectively design, deploy and maintain current- and next-generation networks and network elements.

•  Unified Assurance Solution—Our Unified Assurance solution strategy, which was introduced in early 2003 and includes current and future products, will ultimately be comprised of products that address network, service and customer assurance. Our Unified Assurance solution will transform key performance indicators into actionable intelligence to empower a carrier’s customer service, sales, marketing and network operations organizations to proactively manage the quality of service delivered to its most valuable customers. The key benefits of our Unified Assurance solution will include opportunities for improved acquisition and retention rates of high-value customers, streamlined operational support systems, reduced operating expenses and capital expenditures

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resulting from increased organizational efficiencies, and informed business planning. Products and applications that we currently offer as part of our network assurance and service assurance solutions help carriers achieve many of these benefits today. Carriers that use our complete Unified Assurance solution will be able to simultaneously manage their voice and data services at the network, service and customer layers in an interactive and real-time manner to proactively detect network and service problems and identify the customers most impacted by any service degradation. Our Unified Assurance solution is comprised of the following:

A variety of applications will be available for each product so that our customers can customize the system to meet their specific needs and objectives. Carriers can purchase our products individually or as the complete Unified Assurance solution. A key capability of the complete Unified Assurance solution will be its ability to seamlessly link workforce processes and activities among a carrier’s network, service and customer-facing organizations and to do so across multiple voice and data technologies. The resulting benefit is that carriers will be able to achieve high levels of network assurance across multiple technologies, service assurance across multiple networks and customer assurance across multiple services.

•  Diagnostics Solutions—Our diagnostics solutions are used by communications carriers and equipment manufacturers for commissioning, interoperability testing and on-going maintenance of communications networks, as well as the development of revenue-generating services. We currently offer three products in the diagnostics area—the Spectra2^TM, which addresses next-generation communications networks, and the Spectra^TM and Spectra Trunk Tester^TM, which address current-generation communications networks. These multi-protocol analyzers provide diagnostic, emulation and load generation capabilities for use in the design, deployment, commissioning and diagnosis of current- and next-generation networks and network elements.

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Founded in 1989, our mission is to be a leading provider of communications software solutions for current- and next-generation carriers and equipment manufacturers worldwide. Key elements of our strategy to achieve this objective include:

As of December 31, 2002, we had sold our solutions to more than 640 customers in approximately 65 countries. Our target customers include current- and next-generation tier-one wireless and wireline carriers as well as communications equipment manufacturers throughout Europe, the Middle East and Africa, or collectively EMEA, North America and select countries in the Asia/Pacific region. A partial list of our carrier customers includes Alltel, AT&T, British Telecom, Deutsche Telekom, Global Crossing, O₂ (formerly BT Cellnet), Orange Communications, PTK Centertel, Qwest Communications, Sprint, Swisscom Fixnet, Swisscom Mobile, Telekom Austria, Telstra, T-Mobile USA (formerly Voicestream), TTNet, Vodafone and WorldCom. A partial list of our equipment manufacturer customers includes Alcatel, Cisco, Lucent, Motorola and Nortel.

Industry Background

The Communications Industry

Historically, fixed-line communications carriers operated in a highly-regulated environment with little or no competition. During the past two decades, many governments worldwide have significantly deregulated the communications industry. Deregulation increased the competitive landscape by allowing the emergence of competitive communications carriers. The increased competition created by deregulation put pressure on all communications carriers to differentiate themselves from competitors. Differentiation was initially achieved by providing advanced, value-added services and features (such as toll-free “800” numbers, caller ID, three-way calling, voice messaging and internet access) at compelling prices with competitive subsidies while delivering a high level of quality of service to customers. The result was an increase in the number of communications service providers and options available to consumers.

Also, over the past decade, mobile communications and related technologies have been developed to enable mobile communications services to become available at reasonable prices, although initially at questionable quality levels. Mobile communications carriers have invested heavily in infrastructure and handset technologies, and have spent significant sums in acquiring and retaining subscribers to build market share.

Over the past two to three years, the communications industry has experienced depressed economic conditions. Today, many communications service providers are faced with challenging financial conditions. These factors have contributed to increased consolidation within the industry and have forced many carriers to focus on survival. As a result, the mode of differentiation has changed—most carriers now offer a similar suite of services, sell them for near the same price and

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offer comparable subsidies to subscribers. One of the few strategic differentiators—and one that the carrier can control—is the quality of service provided to its customers. To remain competitive, carriers must provide a high level of service quality and reliability. The emphasis has shifted from network expansion, capacity growth and the acquisition of customers at any price to managing performance and service quality in an effort to maintain the existing customer base. The ability to provide and ensure high-performing services to customers is a key to minimizing customer turnover, or churn, in a carrier’s customer base. In addition to an increased emphasis on quality of service delivered, carriers continue to look for ways to reduce network operating costs and capital expenditures.

Signaling and Modern Communications Network Architectures

The following discussion of the evolution of communications networks and related signaling is provided to help illustrate the increased complexity of these networks as they have evolved and some of the specific needs that our solutions address.

A communications network must not only convey information between points, it must also determine the best routes for connections, control the allocation of resources used to transfer the information and keep transaction records for billing and measurement purposes. A communications session involves two types of information: the session content (voice, computer data or video) and information about the session (such as the identities of the party initiating the session and the destination party) that is required to connect, manage and bill for the session. This intelligence about a communications session or other services is generally referred to as signaling, or the “command and control” of the network.

The first generation of telephone networks was designed to pass both call content and signaling over a dedicated internal network path, called a trunk, from the source of the call to the called destination. This approach was referred to as in-band signaling. These networks used analog transmission for voice and signaling. Signaling information was passed in a single path through audio tones or voltage changes on the telephone line or trunk connection. However, this single path method of transferring both call content and signaling became inefficient and unreliable as network traffic grew, leading to network congestion and reduced service quality. In-band signaling also inhibited or prevented many advanced service offerings because the control information could not be separated easily from the call content flowing over a trunk.

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These problems were first recognized during the 1960s and subsequently were resolved through the development and deployment of common channel signaling. In common channel signaling, the call content is separated from the signaling information. The signaling information is then passed over an entirely separate physical path through the carrier’s network, while the call content is passed over a trunk. Signaling paths in the network are connected to a set of systems that control and monitor the progress of calls and other transactions and route the signaling information as required. The signaling paths, or links, and signaling network control systems comprise a separate network infrastructure, called a signaling network, that operates in parallel with the network of trunks used to convey call content. The technique is called common channel signaling because signaling information for multiple calls passes over a shared, or common, set of signaling channels. This method of combining signaling information for multiple calls results in much higher overall network efficiency. With the introduction of common channel signaling and the evolution of a separate signaling network infrastructure, the signaling is delivered via a packet-based network architecture while the voice network transmits the call content using analog Time Division Multiplex, or TDM, signals.

Traditional signaling networks are based on a globally standardized architecture and set of protocols called Common Channel Signaling System #7, or SS7, or sometimes referred to internationally as C7. Since the mid-1980s, SS7 has been implemented by communications carriers worldwide, including incumbent carriers, competitive service providers, internet service providers and wireless carriers. SS7 utilizes digital packet-switching technology and is designed to be robust, flexible and scalable, enabling communications carriers to provide new services quickly and to optimize the network bandwidth used for trunk connections. When a call is placed, the originating location’s call switching equipment uses the SS7 network to look ahead and determine whether the destination is busy or otherwise unavailable before allocating a trunk to the call and connecting both parties, thus optimizing network trunk capacity utilization. This look-ahead operation also enables information such as caller ID to be passed before the call is actually connected. The SS7 network’s speed and power allow these operations to occur almost instantly, which significantly reduces the time required to process each call and improves service to the end user.

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The network intelligence that SS7 provides in current networks is the keystone to the adoption of next-generation Internet Protocol, or IP, packet-based networks. In these next-generation networks, the call content—as well as the signaling—will coexist in a packet-based network. This is similar to the example of in-band signaling; however, the packet-based environment is more robust and flexible. Natively within the next-generation packet network, the intelligence for control is carried in virtual channels, which are comparable to SS7 signaling links in the current networks. The protocol or language of this intelligence may take many forms, such as Session Initiation Protocol, or SIP.

As with the evolution of past communications networks, we believe it will be a number of years before IP networks become the prevailing standard for voice communications. Until then, both types of networks will be in use and must be able to coexist. Collectively, SS7, SIP and other languages formulate the intelligence of current- and next-generation networks. These languages route and connect calls among similar, as well as between dissimilar networks. For current- and next-generation networks to interoperate successfully, SS7 must interact with its signaling peer in the IP environment and enable calls to be exchanged between these two different types of networks. This interaction occurs through network infrastructure gateways, and may be managed and maintained with systems such as our GeoProbe and Spectra.

Wireless Network Overview

Signaling is also critical in wireless communications. In fact, wireless networks are inherently more complex than wireline networks, generating a greater volume of signaling messages due to roaming, customer authentication and wireless transactions in addition to basic call setup. In addition to these wireless-specific activities that increase the level of signaling traffic, Short Message Service,

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or SMS, text messages are carried through the signaling network. Therefore, as SMS traffic increases, signaling network traffic increases as well.

The most prevalent wireless network technology in the world today is Global System for Mobile Communications, or GSM. Next-generation wireless data networks for GSM include General Packet Radio Service, or GPRS (also referred to as 2.5G wireless), and Universal Mobile Telecommunications System, or UMTS (also referred to as 3G wireless). Eventually, these future-generation wireless networks will enable voice and data to coexist on the same network. We believe that the efficient management of these networks will present new challenges for wireless service providers.

The vision of seamless integration of voice and data is being realized through the current- and next-generations of wireless technologies and signaling transactions. In recent years, wireless service providers have incurred a significant level of capital expenditures to increase network coverage and roll out next-generation network technologies, such as GPRS, to deliver multimedia communications. Now that many of these carriers have mobile data and voice network footprints in place, their emphasis has shifted from network expansion to the management of these multiple technologies. In addition to the basic need for network management, carriers are concurrently moving towards more proactive performance management at the service and customer layers. We believe that this shift towards proactive performance management, the extremely competitive environment for wireless services and the challenges associated with managing multiple technologies present a significant opportunity for us.

GPRS Network Overview

From a carrier’s perspective, GPRS technology is advantageous because it enables packet-based data capability by utilizing existing radio spectrum and provides faster data speeds, which are better suited for Internet traffic. From the perspective of the subscriber, connection setup is very fast and voice and data calls can be handled simultaneously. For GPRS and wireless voice networks installed today, the principle network elements that transmit signaling traffic include:

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wireless communications. For GPRS, the mobile device must be able to support packet-data capability. The mobile device transmits and receives information to and from the base station nearest its current location.

Large tracking databases, called registers, are continuously updated to reflect changes in the network regarding mobile devices and their users. The primary registers include:

Wireless carriers use the signaling network to transport the information needed to establish a voice call in addition to the information to perform wireless transactions such as those described below. Wireless transactions are increasing in importance as the adoption of mobile data services continues to increase. One of the most popular wireless transaction types is SMS messaging. SMS messages are transactions sent through a wireless carrier’s signaling network. According to the GSM Association, approximately 30 billion SMS messages are sent in a month on a global basis.

A wireless carrier performs many transactions transparent to the user that are associated with any mobile device whether or not it is in use. Examples include:

GPRS Wireless Data: An Illustrative Example

In order to better illustrate the complexity involved with GPRS technology and the critical role of signaling in wireless data networks, consider the example of a subscriber in England using his GPRS phone to read his e-mail.

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When the subscriber turns on his phone, the device transmits a signaling transaction to the closest base station. The base station receives the signaling transaction and requests registration in the network. In the case of GPRS, the registration can be sent to both the SGSN to notify the data network and the MSC/VLR to notify the voice network of the user’s status. In another series of transactions with the HLR, the mobile device is checked to make sure it is registered and has not been stolen.

After these initial transactions are completed, the mobile device is authorized to begin exchanging data. To initiate the data session, the mobile device sends a context (session) request to begin exchanging e-mail information. This context request is received by the SGSN and then routed to the appropriate GGSN for the e-mail information for this subscriber. The GGSN then establishes a connection through the IP data network with the e-mail server. Once this is accomplished, the subscriber can then read and send e-mails from his mobile device.

This scenario becomes more complex when the subscriber is roaming. In this case, location update messages are sent when the subscriber moves between different SGSNs or MSCs so that service is not disrupted.

The need for a tool with protocol monitoring capability is far greater in GPRS than in any other network. With the merging of the mobile network, the IP network and the SS7 network—and the fact that multiple vendors are used in almost all of these networks—an end-to-end view of the subscriber experience is more important, and more difficult to ascertain, than in the past. The architecture of our solutions is capable of collecting, correlating, presenting and saving network-wide information to be used for real-time management or planning purposes.

The Need for a Unified Approach to Network, Service and Customer Assurance

Our solutions provide intelligence to help carriers proactively and strategically manage their businesses in today’s complex environment. As the example above illustrates, even a relatively simple communications session requires a sophisticated series of signaling-related transactions. Wireless data, mobility of subscribers, SMS and other advanced services increase the number of signaling messages required for each session, which in turn tends to increase the number of network elements, the complexity of the elements and the links required in the network. As carriers roll out new services and technologies, network complexity increases, which makes performance management more of a challenge.

Proactive performance management and the ability to manage multiple network technologies are necessary for a carrier to achieve a holistic view of its networks. If network problems are not detected on a timely basis, they can result in service and network downtime, which will result in a negative experience for customers. The challenge with many performance management solutions today is the absence of transparency or linkage between actual network problems and the services and customers being impacted by the problems. We believe that for a carrier to truly manage its business strategically, it must have the ability to link activity among the network, service and customer layers.

Using a unified approach to performance management, once a problem is detected at the network level, operations engineers can determine what services are being impacted by the problem and, more specifically, which customers are experiencing service degradation as a result of the problem. Alternatively, if a customer service representative notices that a high-value customer is experiencing quality problems, the troubleshooting process can be expedited by determining the specific services or network elements causing the problem. Once the root cause of the problem is determined, operations personnel can prioritize their efforts to focus on resolving the issues that will positively impact the most important customers experiencing service degradation. We believe that providing a unified view of information across multiple networks and technologies—and linking that information

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from a network, service and customer perspective—is critical for a carrier to successfully manage the quality of service delivered to its highest-value customers.

The Inet Strategy

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

Continuing to Strive for the Highest Level of Customer Satisfaction. Since our inception in 1989, customer satisfaction has been a primary goal of ours. Our customers include some of the largest communications carriers and equipment manufacturers in the world, and we view our customer base as one of our greatest assets. Based on experience with our existing customers, we believe that achieving early widespread deployment of our solutions in a particular carrier’s network and achieving high levels of customer satisfaction provide significant ongoing opportunities for sales of new and expansion systems, additional applications and other new offerings. As an example, our existing customers have generated a large portion of our revenues historically—in excess of 90% in recent quarters. A key element of our strategy is to continue to leverage additional revenue opportunities with our customer base. We intend to do this by working closely with our installed customer base to identify opportunities for the sale of expansion systems, additional applications and new products as they become available. To successfully achieve this goal, we believe it is critical that we maintain and strengthen our existing customer relationships.

Developing Solutions for the Current- and Next-Generation Wireless Data and Voice Markets. Historically, demand for our products has been driven by the deregulation of communications markets worldwide and growth in fixed-line networks. Today, most of the large global fixed-line carriers employ a basic network management system, such as our GeoProbe product. Because wireless carriers have most recently been focused on network expansion, the penetration of network management systems within wireless networks is lower than that of wireline networks. We believe that the focus of wireless providers has recently shifted from network expansion to network, service and customer performance management. We believe that this shift towards proactive performance management, the extremely competitive environment for wireless services and the challenges of managing multiple technologies present a growth opportunity for us. We also believe that the rollout of next-generation wireless technologies, specifically GPRS, further increases the opportunity for us. As a result of these factors, the majority of our sales and marketing and product development efforts are targeted towards the mobile data and wireless voice markets.

Focusing on Sales to Tier-One Communications Carriers and Equipment Manufacturers in Key Geographic Regions. We are pursuing business throughout the world in markets that we believe offer the most significant and profitable growth opportunities. We have made the decision to focus our direct sales and marketing efforts in North America, Europe and select countries in the Asia/Pacific region with the majority of our efforts targeted toward the current- and next-generation tier-one wireless and wireline carriers and communications equipment manufacturers. The percentage of our revenues attributable to international markets was 72% in 2002 and is expected to remain a majority of our revenues going forward. We intend to expand our global market share by cultivating our relationships with existing customers, targeting large mobile and fixed-line carriers that are not currently customers and adding resellers in key global markets as business conditions warrant. Our focus on tier-one carriers is fueled by two primary factors. First, the capability of our solutions to scale to support the world’s largest communications networks and the wide range of applications we offer provide us with a strong competitive position. Second, we believe the tier-one carriers will survive and emerge from the current slowdown aiming to streamline and optimize their operations and will be willing to commit the substantial resources required to purchase and maintain sophisticated systems and applications such as the ones we offer.

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Investing in Research and Development to Provide Technological Leadership and to Broaden Our Product Portfolio. Much of our success to date has been driven by our ability to develop new products and applications to sell to communications carriers and equipment manufacturers. We believe that we have gained significant expertise in communications technologies and related signaling protocols in the course of the design, development and implementation of our current product offerings and through our work with our existing customer base. We intend to leverage this core competency and continue to invest in the strategic area of research and development, or R&D, to facilitate differentiation through the performance, features and scalability of our products as well as the breadth and depth of our product portfolio. We believe that continued R&D investments—for both new product development and enhancements to our current offerings—will help us maintain or strengthen our position as a technological leader in our chosen markets. We also believe that the addition of new products and applications to our existing product portfolio will facilitate our ability to acquire new customers and further penetrate our existing customer base. Therefore, we plan to continue to invest in next-generation communications technologies such as GPRS, UMTS and voice-over-packet.

Managing for Profitability. Since our inception, we have managed our business for profitability. We believe continued profitability is critical to maintain our high level of investment in new product development, provide a positive future for our employees and create value for our stockholders. Over the past two to three years as the economy has weakened and demand for our products has slowed, we have taken actions to align our cost structure with the reduced level of business. As a result of these actions, we have continued to be profitable despite a challenging market environment. We intend to continue to aggressively manage and monitor our cost structure.

The Inet Solutions

We provide communications software solutions that enable communications carriers to more strategically operate their businesses. Our current and future solutions include the following:

Unified Assurance Solution

We have been delivering network management solutions to communications carriers since 1995. Recently, we believe industry trends have begun to shift: carriers that were once focused on the rapid acquisition of customers at any cost and expansion of their networks are shifting their efforts to reduce operating and capital expenditures, streamline operational support systems and to focus on the maintenance of high-value customers to minimize churn and maximize revenues and profitability. Because of this fundamental change in carriers’ business needs, our product strategy has evolved and we have broadened our product portfolio.

In early 2003, we introduced our Unified Assurance solution strategy, which includes current and future products that address network, service and customer assurance. A key capability of the Unified Assurance solution will be its ability to seamlessly link workforce processes and activities among a carrier’s network, service and customer-facing organizations and to do so across multiple voice and data technologies. The resulting benefit is that carriers will be able to achieve the following:

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Using our Unified Assurance solution, communications carriers will be able to simultaneously manage their voice and data services at the network, service and customer layers in an interactive and real-time manner to proactively detect network and service problems and identify the customers most impacted by any service degradation. This solution will transform key performance indicators into actionable intelligence to empower a carrier’s customer service, sales, marketing and network operations organizations to proactively manage the quality of service delivered to its most valuable customers.

The key benefits of our Unified Assurance solution will include opportunities for improved acquisition and retention rates of high-value customers, streamlined operational support systems, reduced operating expenses and capital expenditures resulting from increased organizational efficiencies, and informed business planning. Products and applications that we currently offer as part of our network assurance and service assurance solutions help carriers achieve many of these benefits today.

A variety of applications will be available for each product so that our customers can customize the system to meet their specific needs and objectives. Carriers can purchase our products individually or as the complete Unified Assurance solution.

Network Assurance

Our product to address network assurance is the GeoProbe. The GeoProbe, which was initially introduced in late 1995, is used by both wireless and fixed-line communications carriers to proactively monitor, manage and diagnose the overall health of voice and data networks based on performance metrics. We also offer a suite of revenue assurance applications as part of our network assurance solution. These revenue assurance applications, fueled by the GeoProbe, were formerly marketed as part of our IT:seven business intelligence applications.

Network engineers use the GeoProbe for:

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

The GeoProbe can provide a network-wide view regardless of topology, number of protocols or number of different vendor elements in use. It passively, or non-intrusively, monitors all messages that flow over each signaling link and can automatically correlate these messages in real time to reconstruct every voice and data session in a carrier’s network. This capability provides session analysis for troubleshooting, problem detection and network integrity assurance. In addition, the information collected by the GeoProbe improves a carrier’s ability to optimize the performance of its network.

The GeoProbe provides session and network status information to users through a graphical user interface, or GUI, and through Web-based reporting and analysis applications. The GUI displays maps that represent network elements, such as SGSNs, GGSNs, MSCs, Base Station Controllers, or BSCs, or Signal Transfer Points, or STPs. The GeoProbe also provides users with the flexibility to configure their system to set up triggers to detect events, filters, alarms and statistics based on their specific needs. When failures or user-specified events occur, an icon representing the affected network element changes colors to alert the user to potential trouble or the occurrence of the failure or event.

The platform’s modular design accommodates growth in a carrier’s network and facilitates the implementation of enhanced features simply by the addition of processor cards to the system or deployment of additional system components in conjunction with adding software capabilities.

We have developed a number of advanced network monitoring software applications for use with the GeoProbe, including network surveillance and troubleshooting, fraud prevention and network security applications. All GeoProbe applications are based on data captured directly from the signaling network, as opposed to information provided in vendor-specific format by individual network elements. As a result, carriers can use the GeoProbe to gain an independent view regardless of which vendor’s equipment is deployed in their signaling network. Our open interfaces allow the carrier’s personnel or a third-party software developer to expand or customize existing applications or develop new applications using data collected by the GeoProbe.

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

Another advantage of the GeoProbe is its ability to collect, process and present information in real time, even under extreme network load conditions. This key attribute makes real-time management and operation of signaling networks possible. Without a real-time monitoring system, carrier networks are more vulnerable to overloads, fraud and delayed problem resolution, which can lead to network failure, customer dissatisfaction and compromised network integrity.

Other advantages include advanced engineering and proactive planning capabilities. The GeoProbe provides an accurate and detailed view of real-time and historical statistics on a carrier’s signaling network usage and the service applications delivered through the network. This allows carriers to implement network architectures optimized for cost and performance, and to refine the

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network’s configuration over time based on changes in demand and traffic patterns. For example, a carrier can use data collected by the GeoProbe to identify a point in the network that is constricting traffic flow. The carrier can then either reroute traffic or install additional capacity at that point, which increases the throughput of its entire network.

Pricing for a GeoProbe system or individual applications varies based on a number of factors, such as the volume of network traffic, network size, network configuration, number of protocols present, number of links monitored and number and type of applications desired. Prices for GeoProbe systems have ranged from less than $500,000 to more than $20 million. Since 1995, we have sold the GeoProbe to approximately 105 customers worldwide.

Service Assurance

Service assurance is the monitoring and delivery by a communications carrier of critical high-value services, such as voice, GPRS, SMS and IP applications. Service assurance ensures that high levels of service quality are sustained for all subscribers across multiple networks. Our product that addresses service assurance is Orion. Orion has two applications that are currently generally available—one that addresses interconnection management and another that addresses customer mobility issues for wireless carriers. The product’s real-time and comprehensive analysis capabilities empower service managers and engineers to immediately initiate corrective actions when service quality falls below acceptable levels, to implement preventive actions to maintain service performance integrity and to continuously monitor performance metrics for planning purposes. We will be introducing new applications and functionality for Orion throughout 2003 that will add the capability for Orion to interact with our customer assurance product to provide the information needed to address the performance of a carrier’s most profitable services, both within and beyond network boundaries.

Networks are connected among multiple carriers, often spanning international boundaries. Interconnection management is a complex task for many carriers. In addition to monitoring and managing its own network performance, a carrier must also monitor and manage the performance delivered beyond network boundaries. Carriers maintain service level agreements, or SLAs, with a number of interconnect partners, which define their roles and responsibilities with respect to interconnection activity, including such matters as fees and quality levels. Interconnection-related revenues and expenses are a core component of a carrier’s business. The failure to proactively manage the quality of interconnection services can have a negative impact on a carrier’s business in terms of lost revenue opportunities, increased operating costs and higher customer churn.

One of our initial Orion applications, Interconnection Voice Assurance, or IVA, addresses interconnection management. IVA enables mobile and fixed-line carriers to proactively manage and enforce voice traffic SLAs with interconnect partners. A carrier providing interconnection services to other carriers must proactively manage its performance to minimize service quality issues. Alternatively, carriers that use interconnect partners to transport voice traffic must monitor the performance delivered by those partners to ensure that agreed-upon quality levels are met.

The IVA application’s proactive SLA management capability enables carriers to manage and monitor, in real-time, the transport, delivery and performance of the interconnecting voice calls they complete. Flexible alarms and dynamic displays generated by the application alert operations personnel to network problems preventing interconnect call completions. Thus, by quickly identifying and resolving network congestion and other issues, interconnect call completion rates are improved and interconnection revenues are protected. Real-time and comparative trending information provides a comprehensive view of all interconnection activity and visibility into events occurring prior to failures. Voice performance metrics and service levels can be tracked by individual interconnect partner or by served destination.

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A carrier utilizing other carriers to transport interconnection traffic can proactively monitor the performance delivered by interconnect partner providers and take action when performance falls below acceptable levels. In addition, using the specific carrier and destination performance data provided by the application, carriers can make least-cost and best-value routing decisions by optimizing carrier and route selections. Preferred partners can be selected and utilized based on the overall quality of service provided, or the quality provided to specific destinations. Carriers can also use performance documentation to negotiate more favorable terms with partner providers. Proactive management can reduce the overall costs of interconnection for a carrier.

Another Orion application currently available addresses customer mobility issues for wireless carriers. The application helps measure the quality of service of mobility traffic and SMS traffic to and from a carrier’s interconnect and roaming partners.

Orion is delivered on our purpose-specific platform that enables real-time collection and correlation of data generated from a carrier’s signaling network. The Orion applications are web-based and offer a wide variety of reporting options for the user. The dynamic reporting and analysis tools are fueled by real-time or historical data, depending on the customer’s preference, and include instant analysis capabilities, historical comparative trending and report personalization. These reporting tools can be used to demonstrate service performance delivered to interconnect partners and a carrier’s own customers. Operations personnel are also able to make more informed business decisions given the historical reporting and trending capabilities.

Pricing for our Orion product varies based on a number of factors, such as the volume of interconnection traffic and the number and type of applications and reporting packages desired.

Customer Assurance

Our product that will address customer assurance is Beamer. Beamer is currently in beta-test phase and is expected to be generally available later in 2003. Once available, Beamer will provide visibility into the actual quality of service levels experienced by a carrier’s highest-value customers. The product will help carriers achieve organizational efficiencies and improve the acquisition and retention rates of those customers that are most desirable and profitable to them.

Beamer will provide a consistent view of service performance indicators for all services delivered by a carrier to its high-value customers. The product will automatically associate network and other relevant activity with the end-user, which will allow the system to associate both network and service performance degradation to the end users as well as the specific network elements, geographies and other factors involved. This will afford a carrier the ability to identify, prioritize and correct faults at the network and service layers so that its highest-value customers are addressed first.

Beamer will also allow a carrier to determine all high-value customers being adversely impacted by a common fault so that the positive impact of corrective efforts is maximized. The product will be delivered via an open architecture that will allow information to be fed to third-party systems.

Pricing for our Beamer product will be based on a number of factors, such as the number of services monitored, the number and type of applications desired and the number of high-value accounts that a carrier desires to track.

Diagnostics Solutions

Our diagnostics solutions provide communications carriers and equipment manufacturers with the ability to quickly and cost-effectively design, deploy and maintain their networks and network

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elements. We provide vendor-independent tools that provide diagnostic, emulation and load generation capabilities for use in the design, deployment, commissioning and diagnosis of signaling networks as well as quality of service measurement in voice-over-packet networks. Currently, our diagnostics solutions include the Spectra2, which addresses next-generation networks, and the Spectra and Spectra Trunk Tester, which address current-generation networks. These products can be integrated within the GeoProbe platform or used on a stand-alone basis with a carrier’s own equipment. These products are also used by developers and equipment manufacturers in the design of new products through the products’ extensive emulation and conformance packages and their ability to simulate network conditions.

These multi-protocol diagnostic tools are targeted to the needs of next-generation networks using H.323, SIP, Media Gateway Control Protocol, or MGCP, MEGACO (H.248) and SIGTRAN protocols. These tools also support advanced SS7/C7, GSM, IS-41 and ISDN networks and development environments. They are designed for ease-of-use, with an intuitive user interface featuring pop-up menus and single-keystroke commands. These tools can be configured by the user to change message text and monitoring scenarios and to save commonly used configurations, filters, tests and other settings for quick setup. They translate complex signaling messages into plain language, and the display format shows network statistics and test results in an easy-to-understand format.

Our diagnostics solutions provide customers with the ability to monitor, emulate and generate signaling data for use in troubleshooting, validation, conformance and regression testing of switches and other network equipment. The load generation capabilities and multiple emulation functions can test the various layers of the signaling protocol, up to and including the signaling information involved with complex applications, such as local number portability, or LNP, and wireless.

These solutions enable network equipment manufacturers and communications carriers to perform end-to-end testing of applications utilizing multiple signaling protocols, including country-specific variations of signaling. They alleviate the need to use multiple diagnostic tools and provide easy and consolidated access to test results. We support over 450 national, international and proprietary protocol variants.

Prices for a unit generally fall within a range of $50,000 to $70,000. Since the first diagnostic sale in 1990, over 5,300 units have been sold to approximately 585 customers worldwide.

Products Under Development

We utilize an open architecture approach in the design of our products. This approach facilitates and accelerates the development of new applications and products and permits us to enhance existing products by substituting new hardware or software modules. This modular approach helps to extend the life cycles of our products, simplify the manufacturing process and facilitate cost reduction.

Planned product enhancements for our GeoProbe and Orion products include the ability to monitor UMTS and signaling in IP networks as well as the addition of voice and data assurance applications. For Beamer, our planned product enhancements include applications for next-generation wireless and IP data assurance.

Planned product enhancements for our diagnostics solutions include increased call generation capacity and additional support for emerging wireless (UMTS/3G) and Voice over Internet Protocol, or VoIP, signaling protocols.

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Customers

As of December 31, 2002, we had sold our solutions to more than 640 customers in approximately 65 countries. In 2002, British Telecom accounted for approximately 21% and Deutsche Telekom accounted for approximately 11% of our total revenues. In 2001, Deutsche Telekom accounted for approximately 12% of our total revenues. In 2000, British Telecom and WorldCom each accounted for approximately 13% of our total revenues. See Note 8 of our consolidated financial statements included in Part IV, Item 15 of this report for a description of revenues from customers by geographic region. If we were to lose one of our significant customers, our financial results could be harmed.

Our target customers include current- and next-generation tier-one wireless and wireline carriers as well as communications equipment manufacturers throughout EMEA, North America and select countries in the Asia/Pacific region. The following is a sampling of representative customers in various market segments that collectively accounted for approximately 80% of our total revenues in 2002.

Sales, Marketing and Support

Sales and Marketing

We sell our products to communications carriers and equipment manufacturers globally through both direct and indirect channels. Domestically, the direct channel is used for all solution areas. Our domestic sales force is structured around a two-tiered model focused on strategic accounts and geographic areas. Internationally, we use both direct and indirect channels. Our Unified Assurance solutions are sold directly and in cooperation with systems integrators, resellers and consultants, while our diagnostics solutions are sold primarily through resellers. At year-end 2002, we had five sales offices in the U.S. and three sales offices outside the U.S., near London, England, Frankfurt, Germany and Paris, France. We also have a direct sales presence in Sydney, Australia, in Tokyo, Japan, in Seoul, Korea, in Singapore and in Madrid, Spain.

The sales cycle for our solutions can be long, historically averaging from six to 18 months for our network assurance and service assurance solutions (excluding the cycle for subsequent applications and enhancements, which varies widely) and averaging three months for occasional, large sales of our diagnostics products. We expect that the sales cycle for our customer assurance solution will be comparable to that of our network assurance and service assurance solutions.

Our primary marketing activities include raising potential customer awareness of the benefits of proactive performance management as well as identification of new opportunities with existing customers. To accomplish these tasks, we use direct sales and marketing efforts, advertising in trade publications, exhibitions at industry trade shows and presence on the Internet through our Web site.

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These activities focus on generating qualified sales leads and demonstration opportunities for our solutions.

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

Customer Operations, Services, Support and Warranty

We believe that customer service, support and training are important to building and maintaining strong customer relationships. We service, repair and provide technical support for our products. We currently offer two levels of support services that provide either 24-hour, seven days a week or 8-hour, five days a week technical support. Both levels provide for remote access assessment and servicing capabilities, installation support and advance replacements for emergency situations.

We maintain an in-house repair facility and provide on-going telephone assistance to customers from our support center in Richardson, Texas. In addition, we service our customers from product support offices located near London, England and Frankfurt, Germany. As our customers become more geographically diverse and as business conditions warrant, we may open support offices in other key locations.

We typically warrant our products against defects in materials and workmanship for one year. We also provide varying levels of extended product support under support services agreements. Support services agreements are typically sold to customers for a one-year term and may be renewed for additional one-year periods. Customers that do not renew their support services agreements but wish to obtain product updates and new version releases generally are required to purchase such items from us at market prices.

Research and Development

Our primary development facilities are located at our Richardson, Texas headquarters. Our research and development efforts include expenditures for new products, new applications, new features or enhancements for existing products or applications and sustaining engineering activities. Our research and development expenses were $29.8 million in 2002, $39.3 million in 2001 and $34.0 million in 2000. See “The Inet Solutions—Products Under Development” for a discussion of current and planned product enhancements.

Our products and solutions are designed to comply with a significant number of standards and regulations, some of which are evolving as new technologies are deployed. For sales to customers in the U.S., our products must comply with various standards established by Telcordia Technologies, Inc. and the American National Standards Institute. Internationally, our products must comply with standards established by the European Union, communications authorities in various countries as well as with recommendations of the International Telecommunications Union and the European Telephone Standards Institute.

Manufacturing

Our solutions are comprised of both third-party and proprietary hardware. Third-party hardware consists primarily of servers and workstations, which are standard devices configured for our specific needs. For proprietary hardware, our internal production process consists of procurement and inspection of various components, primarily circuit boards and racks; final system assembly; system burn-in and quality control testing; and packaging. Internal integration processes are performed primarily at our headquarters in Richardson, Texas. We outsource the manufacturing of our proprietary hardware to a number of Texas-based contract manufacturers. We have obtained ISO

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9001 certification for in-house processes, and we comply with the CE standard for shipments to the territory of the European Union.

We generally use industry-standard components, which are available from multiple sources. However, our products currently utilize various components that are available from only one manufacturer or a limited number of suppliers. We attempt to minimize the need for sole and limited source components when feasible by performing design reviews prior to the manufacture of any new product or redesign of an existing product. We forecast our parts usage on an ongoing basis and meet with key vendors to obtain their commitment to meet forecasted supply needs. As necessary, we reevaluate the sources of components identified as having potential delivery or other risks and the costs and benefits of redesigning our products to incorporate alternative components. If any sole or limited source components should become unavailable, we believe that we could design similar functionality into our products using other components, although the amount of time and effort required could vary widely depending on the product involved and the function and complexity of the component.

Competition

We compete with a number of U.S. and international suppliers that vary in size and in the scope and breadth of the products and services offered. Our network assurance and service assurance solutions principally compete with products offered by Agilent Technologies and, to a lesser extent, NetTest, Tekelec and Tektronix. The market for our customer assurance solutions is somewhat new and extremely fragmented, and we believe there are not other companies that offer an entire suite of applications in this area. As a result, we compete with various companies on an application-by-application basis, including companies listed above as competitors in our network assurance and service assurance solution areas, and other companies whose main business is geared towards customer care solutions. Our diagnostics solutions principally compete with products offered by Agilent Technologies, Catapult Communications and Tektronix.

We believe that our ability to compete successfully depends on numerous factors, both within and outside our control, including: responsiveness to customer needs; our ability to support existing and new industry standards; the development of technical innovations; the attraction and retention of qualified personnel; regulatory changes; the quality, reliability and security of our products and services and our competitors’ products and services; sufficient market presence by us; ease of use of our products; the pricing policies of our competitors and suppliers; the timing of introductions of new products and services by us and our competitors; and general market and economic conditions.

Proprietary Rights

Our continued success is dependent in part upon our proprietary technology. To protect our proprietary technology, we rely on a combination of technical innovation, trade secret, copyright and trademark laws, non-disclosure agreements and, to a lesser extent, patents, each of which affords only limited protection. In addition, the laws of some foreign countries do not protect our proprietary rights in the products to the same extent as do the laws of the U.S. We hold several U.S. patents, and although we have additional patent applications pending, we cannot assure you that we will be granted additional patents. Despite the measures taken by us, it may be possible for a third party to copy or otherwise obtain and use our proprietary technology and information without authorization.

We rely upon certain software that we license from Oracle Corporation, Cognos Incorporated and other third parties, including software that is integrated with our internally developed software and used in our products to perform key functions.

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The trademarks Inet, Inet Technologies, GeoProbe, Unified Assurance, Beamer, Orion, Spectra, Spectra Trunk Tester, Spectra2 and VIA used herein are registered or unregistered trademarks owned by us. Other trademarks are owned by their respective owners.

Where You Can Find Other Information

We file annual, quarterly, current and other reports, proxy statements and other information with the Securities and Exchange Commission, or SEC, pursuant to the Securities Exchange Act of 1934, as amended, or the Exchange Act. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the SEC’s Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and other information statements, and other information regarding issuers, including us, that file electronically with the SEC. The address of that site is http://www.sec.gov.

We maintain an Internet site, the address of which is www.inet.com. We make available free of charge through this site, under the heading “SEC Filings” at the address http://www.inet.com/investors/index.htm, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

Employees

As of December 31, 2002, we had 470 employees, of which 247 were engaged in research and development, 62 were engaged in sales and marketing, 121 were engaged in operations and 40 were engaged in administrative and other business support functions.

Item 2. Properties.

We are headquartered in Richardson, Texas, under a lease that expires in 2010. In the U.S., we also lease offices for sales personnel in California, New Jersey, Pennsylvania and Washington. These leases expire on various dates through 2003. Outside the U.S., we lease offices near London, England and Frankfurt, Germany, for product service and sales personnel, and near Paris, France, for sales personnel. These leases expire on various dates through 2013.

Item 3. Legal Proceedings.

We are involved in various legal proceedings and claims that arise in the normal course of our business. While many of these matters involve inherent uncertainty, our management believes that the amount of the liability, if any, ultimately incurred by us with respect to any existing proceedings and claims, net of applicable reserves and available insurance, will not materially harm our business, financial condition or results of operations.

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

No matters were submitted to a vote of security holders during the fourth quarter of 2002.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

Our common stock is publicly traded on the Nasdaq Stock Market under the symbol “INTI.” The following table sets forth, for the periods indicated, the high and low sales prices for our common stock as reported on the Nasdaq Stock Market.

On February 27, 2003, the last reported sales price of our common stock on the Nasdaq Stock Market was $7.55 per share. As of February 27, 2003, there were approximately 129 stockholders of record (not including beneficial holders of stock held in street name) of our common stock.

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

On May 26, 1999, the SEC declared effective our registration statement on Form S-1 (File No. 333-59753) relating to the initial public offering of our common stock. As of December 31, 2002, we have used all of the net offering proceeds for the purchase of temporary investments, consisting of cash, cash equivalents, and short-term investments. We currently intend to use the net proceeds of the offering for working capital and general corporate purposes, including financing accounts receivable and capital expenditures made in the ordinary course of business. We also may apply a portion of the proceeds of the offering to acquire businesses, products and technologies, or enter into joint venture arrangements, that are complementary to our business and product offerings; however, at this time we have not identified a specific acquisition or joint venture or allocated a specific amount for this purpose.

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Item 6. Selected Financial Data.

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

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

Overview

We are a leading global provider of communications software solutions that enable communications carriers to more strategically operate their businesses. Current offerings in our Unified Assurance solution convert network information into valuable and actionable intelligence that carriers use to help ensure the health of their revenue-generating infrastructure. These real-time powered solutions help carriers realize organizational efficiencies in managing their operations. Our diagnostics solutions allow communications carriers and equipment manufacturers to quickly and cost-effectively design, deploy and maintain current- and next-generation networks and network elements.

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Historically, we have generated substantially all of our revenues from sales of our GeoProbe and Spectra products as well as sales from applications that were formerly marketed as our IT:seven business intelligence applications. All other revenues are derived from services relating to our products, including training, warranty and product support. In early 2003, we introduced our Unified Assurance solution strategy. Under this strategy, the GeoProbe is our product to address network assurance. In addition to the GeoProbe, we offer a suite of revenue assurance applications as part of our network assurance solution that were formerly marketed as part of our IT:seven business intelligence applications. The remaining IT:seven applications that addressed interconnection management and wireless customer roaming issues are now marketed as applications of Orion, our product that addresses service assurance. Revenues attributable to the GeoProbe have represented a majority of our total revenues since 1998. We expect revenues from our Unified Assurance solutions will represent a majority of our revenues in the foreseeable future.

Results of Operations

The following table sets forth, for the periods indicated, the percentage of total revenues represented by certain items reflected in our consolidated statements of operations:

Revenues

Product and license fees. Revenues from product and license fees decreased 11.3% to $74.6 million in 2002 from $84.1 million in 2001, and decreased 40.2% in 2001 from $140.6 million in 2000. In 2002, the decline in revenues from product and license fees was primarily attributable to significantly lower demand for our diagnostics solutions and slightly lower levels of business for our network assurance and service assurance solutions. We believe that these decreases are attributable primarily to decreased capital spending by communications carriers and equipment manufacturers, which we believe is driven by their need to conserve cash. In 2002, for our diagnostics solutions, we experienced a decrease in the total number of system transactions of approximately 33% and experienced a decrease in the average system transaction size by approximately 11%. In addition, we continue to experience pressure on sales prices within our network assurance solutions area, specifically for those applications for which there is a competitive offering, or in highly competitive situations involving prospective customers. Although the typical bundle of applications for our

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network assurance and service assurance solutions sold in 2002 was different than the typical bundle sold in 2001, we believe prices for our most basic network assurance applications decreased approximately 20% to 30% during 2002. In addition, in 2002, for our network and service assurance solutions, we experienced a decrease in the average transaction size by approximately 12%, but experienced an increase in the number of transactions by approximately 11%. In 2001, the decline in revenues from product and license fees was primarily attributable to significantly lower sales levels in all product areas of our business, which reflected an overall decrease in demand for our solutions. This decrease was primarily driven by the general slowdown in the economy and the decreased levels of capital spending within the communications sector. We also experienced relatively lower sales prices for our network assurance solutions area, which is expected as applications mature or are duplicated in competitor offerings.

Services. Revenues from services increased 19.1% to $27.3 million in 2002 from $22.9 million in 2001, and increased 24.2% in 2001 from $18.4 million in 2000. The increase in services revenues in both 2002 and 2001 was primarily attributable to a larger installed base of products with customers for which we provide warranty or product support services. During both 2002 and 2001, we had 70 customers who were covered under product support agreements pertaining to our network assurance and service assurance solutions. Going forward, we expect to sell additional applications or expand the footprint of our solutions with existing customers and to add new customers, which should continue to increase our installed base of products. However, we expect that pressure on prices for product support renewals may partially offset the effect of this increase.

Concentration of revenues. In 2002, British Telecom accounted for approximately 21% of total revenues and Deutsche Telekom accounted for approximately 11% of total revenues. In 2001, revenues from Deutsche Telekom accounted for approximately 12% of total revenues. In 2000, revenues from British Telecom and WorldCom each accounted for approximately 13% of total revenues. A large percentage of our revenues are typically derived from a small number of customers, the specific make up of which varies from one quarter to the next. On a quarterly basis, our 10 largest customers have typically accounted for approximately 50% to 80% of total revenues for that quarter. We expect this trend to continue in 2003. If we were to lose one of our significant customers, our financial results could be harmed.

International revenues. International revenues accounted for 72.2% of total revenues in 2002, 61.7% of total revenues in 2001 and 55.8% of total revenues in 2000. Revenues from EMEA accounted for 60.9% of total revenues in 2002, 51.9% of total revenues in 2001 and 44.9% of total revenues in 2000. Since the introduction of our network assurance solution in 1995, we have experienced relatively greater acceptance of our network assurance solution in EMEA versus other regions of the world. Variations in the percentage of total revenues derived from international markets may occur as a result of the economic conditions in the regions in which we operate and the concentration of revenues in a particular period from a small number of customers. In 2003, we expect revenues from international markets to continue to represent the majority of our total revenues.

Cost of Revenues

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 testing of our products. Cost of product and license fees was $26.7 million in 2002, $34.7 million in 2001 and $32.6 million in 2000, representing 35.8% of product and license fees revenues in 2002, 41.3% of product and license fees revenues in 2001 and 23.2% of product and license fees revenues in 2000. During 2002, the decreases in both absolute dollars and as a percentage of product and license fees revenues resulted primarily from decreased hardware costs, which were approximately $5.3 million lower than in 2001, and, to a lesser extent, decreased installation costs, including installation contract labor, which were approximately $1.0 million lower than in 2001. The decrease in hardware costs is

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attributable to a higher percentage of our network assurance implementations during 2002 being derived from expansions of existing systems or from the sales of software applications, rather than new system implementations, which typically have a higher hardware component. The decrease in absolute dollars in 2002 also reflects a reduction of $1.6 million in the amounts charged to cost of revenues for excess and obsolete inventory and canceled purchase commitments. During 2001, the increase in absolute dollars over the prior year was primarily due to increased personnel expenses of approximately $1.3 million, increased expenses associated with a higher level of installation contract labor of approximately $1.1 million and increased charges for excess and obsolete inventory of approximately $1.3 million. These increases were mitigated by decreased hardware costs of approximately $2.2 million, which was attributable to lower sales volumes. The increase in 2001 as a percentage of product and license fees revenues was primarily attributable to these same factors as well as the decreased level of revenues. Generally, quarter to quarter fluctuations are driven by variations in our hardware component, which is driven by our product mix, rather than variations in our conversion costs.

Services. Cost of services consists of expenses, primarily personnel costs, related to our product support, training, and warranty activities. Cost of services was $12.6 million in 2002, $8.9 million in 2001 and $8.6 million in 2000, representing 46.3% of services revenues in 2002, 38.6% of services revenues in 2001 and 46.4% of services revenues in 2000. During the first quarter of 2002, we released a new version of the GeoProbe, which resulted in increased support costs in 2002 compared to 2001. In general, cost of services for product support tends to increase during the rollout of new products or new versions of existing products. 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 work, and the absolute value of these items during a specific period. We expect these trends to continue into the foreseeable future.

Operating Expenses

Research and development expenses. Research and development expenses consist primarily of personnel, contract labor, travel and facilities expenses incurred by our research and development organization. These expenses were $29.8 million in 2002, $39.3 million in 2001 and $34.0 million in 2000, representing 29.3% of total revenues in 2002, 36.8% of total revenues in 2001 and 21.3% of total revenues in 2000. The decreases in absolute dollars and as a percentage of total revenues in 2002 compared to 2001 were attributable to decreased staffing dedicated to research and development activities and, to a lesser extent, decreased use of third-party research and development services, which were $1.2 million lower in 2002 compared to 2001. The average headcount of our research and development organization was 264 in 2002 compared to 306 in 2001. The decrease in headcount was primarily attributable to discontinued research and development efforts with respect to our VIA^TM softswitch offering in the second quarter of 2001. The increase in absolute dollars in 2001 compared to 2000 was primarily due to increased average headcount, higher average wage levels required to retain qualified technical and engineering personnel driven by the then existing tight job market and greater use of third-party research and development services. The increase as a percentage of total revenues in 2001 was attributable to these same factors coupled with the decreased level of revenues.

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. Sales and marketing expenses were $16.5 million in 2002, $18.8 million in 2001 and $20.3 million in 2000, representing 16.2% of total revenues in 2002, 17.6% of total revenues in 2001 and 12.8% of total revenues in 2000. The decreases in absolute dollars and as a percentage of total revenues in 2002 compared to 2001 were attributable to decreased staffing dedicated to sales and marketing activities and cost reduction efforts primarily related to advertising and travel. Advertising costs decreased $0.7 million and travel costs decreased $0.4

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million in 2002 compared to 2001. The average headcount of our sales and marketing organization was 75 in 2002 compared to 90 in 2001. The decrease in absolute dollars in 2001 compared to 2000 was primarily attributable to a decrease in sales commissions, due to lower order levels, and cost reduction efforts primarily related to promotional activities. Promotional costs decreased $0.6 million in 2001 compared to 2000. The increase as a percentage of total revenues in 2001 was primarily attributable to the decreased level of revenues.

General and administrative expenses. General and administrative expenses consist primarily of personnel, facilities and legal and professional expenses of our finance, legal and executive departments. General and administrative expenses were $8.0 million in 2002, $9.7 million in 2001 and $12.3 million in 2000, representing 7.8% of total revenues in 2002, 9.0% of total revenues in 2001 and 7.8% of total revenues in 2000. The decreases in absolute dollars and as a percentage of total revenues in 2002 compared to 2001 were primarily attributable to decreased average headcount. Average headcount in 2002 was 44 compared to 57 in 2001. The decrease in absolute dollars in 2001 compared to 2000 was primarily related to decreased incentive compensation, decreased average headcount and decreased professional fees. The increase as a percentage of total revenues in 2001 was attributable to the decreased level of revenues.

Restructuring costs. We recorded a restructuring charge for the three months ended September 30, 2002 of approximately $0.4 million related primarily to a workforce reduction of approximately 35 employees. The reduction affected all areas of the company. The charge consisted primarily of employee severance of approximately $0.3 million and professional fees and outplacement services of approximately $0.1 million. At December 31, 2002, the balance of these costs that remained to be paid totaled approximately $0.1 million.

In May 2001, we announced our decision to refocus our strategy and streamline operations to reduce our cost structure in response to the generally weakened economic environment and changing demand characteristics in some of our markets. As part of this decision, we discontinued all efforts with respect to our VIA softswitch offering and reduced our workforce by approximately 115 employees. The reduction affected all areas of the company. We recorded a restructuring charge for the three months ended June 30, 2001 of approximately $1.7 million, which consisted of employee severance of approximately $1.1 million, professional fees and outplacement services of approximately $0.3 million and the write-off of assets related to the VIA softswitch of approximately $0.3 million. In the fourth quarter of 2001, we decreased this charge by $0.1 million due to changes in previous estimates related to professional fees. In the third quarter of 2002, we decreased this charge by $0.2 million due to changes in previous estimates related to professional fees and employee-related obligations. All costs associated with this restructuring have been paid.

We recorded a restructuring charge for the three months ended March 31, 2001 of approximately $0.5 million related primarily to a workforce reduction of approximately 40 employees. The reduction affected all areas of the company. The charge consisted primarily of employee severance, professional fees and outplacement services. In the fourth quarter of 2001, we decreased this charge by $0.1 million due to changes in previous estimates related to severance and professional fees. All costs associated with this workforce reduction have been paid.

Other Income

Other income is primarily interest income earned on our cash and cash equivalents. Other income was $2.8 million in 2002, $5.3 million in 2001 and $8.2 million in 2000. The decrease in 2002 compared to 2001 and 2001 compared to 2000 was primarily attributable to the overall decrease in interest rates paid on our investments. In 2002, we recognized a return on our average cash balance of approximately 1.5% compared to approximately 3.8% in 2001 and 6.0% in 2000.

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Provision for Income Taxes

We recorded income tax expense of $3.2 million in 2002 compared to an income tax benefit of $1.3 million in 2001 and income tax expense of $19.9 million in 2000. Our effective income tax rates were 29.4% in 2002, benefit of 117.6% in 2001 and 33.5% in 2000. In 2002, the effective tax rate differed from the 35% statutory corporate tax rate primarily due to the effect of the extraterritorial income exclusion and the utilization of the research and development tax credit. In 2001, the effective tax rate differed from the 35% corporate tax rate primarily due to our lower level of income combined with the effect of the utilization of the research and development tax credit.

Our financial statements reflect net deferred tax assets of $0.8 million as of December 31, 2002, comprised of deductible temporary differences. 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 amounts and projected taxable income, although we cannot assure you that such assets will be realized. The amount of the net deferred tax assets actually realized could vary if there are differences in the timing or amount of future reversals of existing deferred tax amounts or changes in the actual amounts of future taxable income.

Sale of Inet Global Research, L.L.C.

Effective January 1, 2000, we sold our membership interest in Inet Global Research, L.L.C. to Epygi Technologies, Ltd., or Epygi, an entity controlled by Samuel S. Simonian, one of our founders and the chairman of our board, for a cash purchase price of $82,000. No gain or loss was recorded on the sale. This transaction was approved by the independent members of our board of directors. Epygi 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 $0.9 million for these services in 2002, $1.4 million in 2001 and $1.1 million in 2000.

Liquidity and Capital Resources

Since our inception, we have funded our operations and met our capital expenditure requirements primarily through cash flows from operations and to a lesser extent during our initial years of operations through bank borrowings. At December 31, 2002, we had working capital of $182.5 million compared to $170.1 million at December 31, 2001. We had $189.1 million in cash and cash equivalents at December 31, 2002, which is an increase of $34.2 million from $154.9 million in cash and cash equivalents at December 31, 2001. At December 31, 2002, we had no long-term debt.

Cash provided by operating activities was $34.9 million in 2002, $28.9 million in 2001 and $13.9 million in 2000. Operating cash flows in 2002 increased primarily due to increased levels of net income and changes in our operating accounts, most significantly decreased inventory and trade accounts receivable. Inventory levels have decreased because of our proactive measures to use material on-hand and purchase new material only when necessary to support current business levels. Accounts receivable balances have decreased due to slightly lower levels of business and enhanced collection efforts. Operating cash flows in 2001 increased primarily due to collections on trade accounts receivable and receipt of an income tax refund.

Cash used in investing activities was $2.3 million in 2002, $8.5 million in 2001 and $14.2 million in 2000. Net cash used in investing activities in each year was related to purchases of property and equipment. We have reduced our levels of purchases of property and equipment to conserve cash given the tight economic environment.

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Financing activities provided cash of $1.6 million in 2002, $3.0 million in 2001 and $3.8 million in 2000. Net cash provided by financing activities in each year was related to proceeds from the issuance of stock under our stock option and employee stock purchase plans.

Our revolving credit facility expired on August 15, 2001. We believe that our current cash balances are sufficient for our near-term needs, and we therefore chose not to renew or replace the facility.

At December 31, 2002, our future contractual obligations consist principally of commitments under operating leases for our corporate office facility and our facilities near London, England and Frankfurt, Germany. At December 31, 2002, future minimum lease payments under noncancelable operating leases were as follows (in thousands):

We currently have no material commitments for capital expenditures. In 2003, we expect capital expenditures to be slightly higher than levels experienced in 2002.

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.

On January 21, 2003, we repurchased 8,969,984 restricted shares of common stock from one of our founders, who was also a member of our board of directors, for an aggregate cash purchase price of approximately $35.4 million in a privately-negotiated transaction. We funded the transaction with available cash. We believe that our cash balances after this transaction and expected future cash flows will be sufficient to meet our anticipated cash needs for working capital, capital expenditures and other activities for at least the next 12 months. Beyond that, if current sources are not sufficient to meet our needs, we may seek additional equity or debt financing. In addition, any material acquisition of other businesses, products or technologies or material investments in joint ventures could require us to obtain additional equity or debt financing. There can be no assurance that additional financing would be available on acceptable terms, if at all.

Accounting Policies

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

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Revenue Recognition

General. We derive revenues primarily from the sale of products and software license fees as well as services, which include training, warranty and product support services. The majority of the contracts for our network assurance and service assurance solutions contain multiple billing milestones, such as contract award, shipment, installation and acceptance, not all of which are associated with revenue recognition. Except as otherwise discussed below, revenues from product and license fees are recognized in the period that we have completed all hardware manufacturing and/or software development to contractual specifications, factory testing has been completed, the product has been shipped to the customer, the fee is fixed and determinable and collection of the fee is considered probable. When we have significant obligations subsequent to shipment, such as installation and system integration, revenues are recognized when, in our judgment, 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 solutions are typically recognized upon shipment.

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

Percentage-of-completion accounting. Revenues for contracts that require significant software development and are generally in duration in excess of nine months are recognized using the percentage-of-completion method, which relies on estimates of total expected contract costs. We believe that this method is appropriate because of our ability to determine performance milestones and determine dependable estimates of our costs applicable to each phase of a contract. Since the financial reporting of these contracts depends on estimates, which are assessed continually during the term of the contract, costs are subject to revisions as the contract progresses to completion. Revenues from these contracts are recognized upon attainment of the scheduled performance milestones. Revisions in gross margin estimates are reflected in the period in which the facts that give rise to the revisions become known. Favorable changes in estimates result in improved gross margins, and unfavorable changes in estimates result in lower gross margins. Anticipated losses on fixed-price contracts are recognized through cost of revenues when estimable. We had no revenues attributable to contracts under percentage-of-completion accounting in 2002 and less than 5% of our revenues from 2001 and 2000 was attributable to contracts under percentage-of-completion accounting. To date, we have not recorded significant adjustments to revenues and expenses as a result of changes in estimates on long-term contracts.

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Trade Accounts Receivable and Allowance for Doubtful Accounts

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

Inventory Reserves

Inventories are recorded net of allowances for unsalable or obsolete raw materials, work-in-process and finished goods. We evaluate the status of our inventory on a quarterly basis to ensure that the amount recorded in our financial statements reflects the lower of our cost or the value we expect to receive when we sell the inventory. This estimate is based on several factors, including the condition and salability of our inventory and the forecasted demand for the particular products incorporating these components. Based on current backlog and expected orders, we forecast the upcoming usage of current stock. We recognize reserves for obsolete and slow-moving parts ranging from 0% for active parts with sufficient forecasted demand up to 100% for excess parts with insufficient demand or obsolete parts. Amounts in work-in-process and finished goods inventory typically relate to firm orders and, therefore, are not subject to obsolescence risk. If market conditions deteriorate or the expected future demand for our products otherwise decreases, or if changes in our business strategy reduce our need for these components, our estimate of the carrying value of our inventory could be reduced by a material amount.

Income Taxes

In the preparation of our provision for income taxes and determination of whether deferred tax assets will be realized in full or in part, we must estimate several factors. When it is more likely than not that all or some portion of the deferred tax asset will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable. As of December 31, 2002 and 2001, a valuation for deferred tax assets was not deemed necessary. Accordingly, if the facts or financial results were to change, thereby impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of valuation allowance required in any given period. Additionally, our income tax returns are subject to review and examination in the various jurisdictions in which we operate. We are currently not aware of any issues that have been raised by taxing jurisdictions, and management believes that all income tax issues which may be raised as a result of such reviews and examinations in the future will be

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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.

Recent Accounting Pronouncements

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

Risk Factors

You should carefully consider the risks described below before making a decision to invest in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we do not presently know, or that we currently view as immaterial, may also impair our business operations. This report is qualified in its entirety by these risk factors.

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

Our quarterly financial results fluctuate and are difficult to predict.

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

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

Our financial results are also likely to fluctuate due to factors that impact our current and prospective customers. Expenditures by customers tend to vary in cycles that reflect overall economic conditions, individual budgeting and buying patterns and, in some cases, the ability of some of our customers to obtain the financing they require to make capital expenditures. Our business has been adversely affected by a softening economy, and we would be further harmed by a continued decline in the economic prospects of our customers or the economy in general. In many cases, these adverse economic conditions have altered current and prospective customers’ capital spending priorities or budget cycles, which has extended our sales cycle. These adverse effects could continue and could impact our customers’ ability to meet their financial obligations to us. Our business also could be harmed by changes in customer spending patterns reflecting industry trends. For example, customer budgetary constraints have contributed to sales price pressure for some of our solutions and could pressure prices for the renewal of product support agreements for our Unified Assurance solutions, which would adversely affect our revenues. In addition, our financial results historically have been influenced by seasonal fluctuations, with orders and revenues tending to be strongest in the fourth quarter of each year and orders and revenues in our first quarter tending to be lower than the levels achieved in the preceding quarter. We believe that this seasonality has been due in large part to the capital appropriation practices of many of our customers; however, it is unclear how these historical trends will be affected by a continued downturn in the communications industry.

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

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

A large percentage of our revenues are typically derived from a small number of customers. For example, in 2002, approximately 57% of our revenues were derived from our 10 largest customers, with British Telecom accounting for approximately 21% of total revenues and Deutsche Telekom accounting for approximately 11% of total revenues. From time to time, we have experienced even higher concentrations on a quarterly basis, and we expect this trend to continue. Although the customer make-up of our largest projects varies from quarter to quarter, a small number of significant customers frequently account for a significant portion of our revenues in a given period. If we were to lose one of our significant customers, our financial results could be harmed. Additionally, if one or more of these significant customers experiences adverse conditions in its industry or operations, including the continued impact of the current economic downturn and reductions in communications spending, these customers may not be able to meet their ongoing financial obligations to us or complete the purchase of additional products.

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

We have derived substantially all of our revenues from sales of products and related services to the communications industry. Since early 2001, we and a number of other companies have been impacted by reduced spending by communications carriers and equipment manufacturers, and some industry analysts project further spending reductions in future periods. In some cases, the continued viability of some carriers and equipment manufacturers is in question. Our business, financial condition and results of operations could be materially harmed in the event that conditions continue to

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worsen in our industry or in the event there are consolidations or bankruptcies of our current or prospective customers, which could result in reduced revenues or significant write-offs of uncollectible accounts. Slowdowns in spending often cause delays in sales and installations and could cause cancellations of current or planned projects, any of which could harm our financial results in a particular period.

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

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

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

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

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

Sales of our Unified Assurance solutions are made predominantly to large communications carriers and involve significant capital expenditures as well as lengthy sales cycles and implementation processes. Sales to this type of customer generally require an extensive sales effort throughout the customer’s organization and final approval by an executive officer or other senior level approval. We expend substantial funds and management effort pursuing these sales. Additionally, potential customers often maintain comprehensive processes for internal approval, contracting and procurement, which may cause potential sales to be delayed or foregone. As a result of these and other factors, the sales cycle for our solutions is long, historically ranging from six to 18 months for our network assurance and service assurance solutions (excluding the cycle for subsequent applications and enhancements, which varies widely) and averaging three months for occasional, large sales of our diagnostics solutions. We expect that the sales cycle for our customer assurance solution will be comparable to that of our network and service assurance solutions. Accordingly, our

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ability to forecast the timing and amount of specific sales is limited, and the deferral or loss of one or more significant sales could materially harm our financial results in a particular quarter, especially if there are significant sales and marketing expenses associated with any deferred or lost sales.

Our financial results could be materially harmed if demand for our new products is less than we anticipate.

A key component of our strategy is the ability to successfully develop, introduce and market new products and applications within our Unified Assurance solution. 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 and functionality expected by them. We cannot assure you that our current or prospective customers will order these new products and applications.

Also, purchase decisions for certain new products and applications within our Unified Assurance solution may be made by individuals within organizations to which we have no significant existing relationships, such as customer service or sales and marketing departments. We cannot assure you that we will be successful in developing the relationships necessary to sell our Orion and Beamer products and applications.

Increased competition could result in pricing pressure, reduced margins and the loss of market share.

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

Our business depends on retaining our existing key personnel.

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

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

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

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We cannot assure you that we will achieve these objectives.

Over the long term, we expect carrier spending for legacy networks to decrease from current levels, which requires that we develop solutions for networks based on next-generation wireless and emerging packet technologies and standards, such as GPRS, UMTS, IP and Asynchronous Transfer Mode, or ATM. We may not successfully develop competitive products for these technologies and standards, which could harm our business, financial condition and results of operations.

Products as complex as those currently under development by us frequently are subject to delays, and we cannot assure you that we will not encounter difficulties, such as the inability to assign a sufficient number of qualified technical personnel to key projects or other unanticipated causes, that could delay or prevent the successful and timely development, introduction and marketing of these potential new products. Even if such potential new products are developed and introduced, we cannot assure you that they will achieve any significant degree of market acceptance.

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

Historically, revenues from international markets have represented the majority of our total revenues, and we expect revenues from international markets to continue to represent the majority of our total revenues. International business activities involve certain risks, including:

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

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

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

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

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Our inventory may become obsolete or unusable.

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

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

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

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

We rely upon software that we license from Oracle Corporation, Cognos Incorporated and other third parties, including software that is integrated with our internally developed software and used in our products to perform key functions. In certain cases, we are unable to obtain long-term pricing commitments for this software. The inability to maintain any software licenses on commercially reasonable terms could result in shipment delays or reductions until equivalent software could be developed or licensed and integrated into our products.

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

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

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

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

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

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

We may face potential liability for product defects.

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

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

As of January 31, 2003, Samuel S. Simonian and Elie S. Akilian, two of Inet’s founders, beneficially owned approximately 64% of the outstanding shares of our common stock. Consequently, these individuals acting together 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 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, Messrs. Simonian and Akilian are members of our board of directors and have significant influence in directing the actions taken by our board.

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

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

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

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

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

The market price of our common stock has been, and is likely to continue to be, highly volatile and may be significantly affected by factors such as:

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

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

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

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

Our international subsidiaries operate in currencies other than the U.S. dollar, which results in translation gains and losses; however, the U.S. dollar is the functional currency of all our subsidiaries.

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

Currently, our cash is invested in bank deposits and money market funds denominated in U.S. dollars. We account for these investments in accordance with Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments in Debt and Equity Securities. These cash equivalents are treated as available-for-sale under SFAS 115. The carrying value of these cash equivalents approximates fair market value. Our investments are subject to interest rate risk, which is the risk that our financial condition and results of operations could be adversely affected due to movements in interest rates. If interest rates were to change by 50 basis points, or 0.5%, our investment income would be impacted by approximately $0.7 million on an annual basis.

Item 8. Financial Statements and Supplementary Data.

See our consolidated financial statements included in Part IV, Item 15.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

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PART III

Item 10. Directors and Executive Officers of the Registrant.

Information called for by Item 10 will be included under the captions “Election of Directors,” “Executive Compensation” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement for the 2003 Annual Meeting of Stockholders, which information is incorporated in this Annual Report by reference.

Item 11. Executive Compensation.

Information called for by Item 11 will be included under the caption “Executive Compensation” in our Proxy Statement for the 2003 Annual Meeting of Stockholders, which information is incorporated in this Annual Report by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Information called for by Item 12 will be included under the captions “Principal Stockholders” and “Proposal 2, Ratification of 1998 Stock Option/Stock Issuance Plan” in our Proxy Statement for the 2003 Annual Meeting of Stockholders, which information is incorporated in this Annual Report by reference.

Item 13. Certain Relationships and Related Transactions.

Information called for by Item 13 will be included under the caption “Certain Transactions with Management” in our Proxy Statement for the 2003 Annual Meeting of Stockholders, which information is incorporated in this Annual Report by reference.

Item 14. Controls and Procedures.

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PART IV

Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K.

(a) (1) Consolidated Financial Statements

The following consolidated financial statements are filed as part of this Annual Report on the pages indicated:

(2) Consolidated Financial Statement Schedule

Schedules other than those listed are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.

(3) Exhibits

The following exhibits are incorporated in this Annual Report by reference or are filed with this report as indicated below. The exhibits filed with this report have been included only with the copy filed with the SEC. Copies of exhibits will be furnished, upon request, subject to payment of a reasonable fee to reimburse us for our reproduction costs.

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(b) Reports on Form 8-K

We did not file any Current Reports on Form 8-K during the fourth quarter of 2002.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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POWER OF ATTORNEY

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

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

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CERTIFICATION

I, Elie S. Akilian, certify that:

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CERTIFICATION

I, Jeffrey A. Kupp, certify that:

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REPORT OF INDEPENDENT AUDITORS

The Board of Directors

Inet Technologies, Inc.

We have audited the accompanying consolidated balance sheets of Inet Technologies, Inc., or the Company, as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Inet Technologies, Inc. at December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States.

/s/ Ernst & Young LLP

Dallas, Texas

January 27, 2003

F-1

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INET TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

ASSETS

See accompanying notes to consolidated financial statements.

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INET TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)