Certain stock options have been granted with exercise prices below the fair market value of the options on the date of grant. The following table illustrates the effect on stock-based compensation, net income and earnings per share on a pro forma basis as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation (in thousands, except per share data):

5. Earnings per Share

     Basic earnings per share is based on the weighted average number of common shares outstanding during the period. Diluted earnings per share is based on the weighted average number of common shares and dilutive potential common shares outstanding during the period.

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IXIA

Notes to Condensed Consolidated Financial Statements

     The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2003 and 2002 (in thousands, except per share data):

6. Concentrations

International Revenues:

     Net revenues from international product shipments were $6.2 million and $3.2 million for the three months ended September 30, 2003 and 2002, respectively, and $17.7 million and $11.1 million for the nine months ended September 30, 2003 and 2002, respectively.

Significant Customer:

     For the three and nine months ended September 30, 2003 and 2002, only one customer comprised more than 10% of net revenues as follows (in thousands, except percentages):

     As of September 30, 2003 and December 31, 2002, the Company had receivable balances from the customer approximating 26% and 19%, respectively, of total accounts receivable.

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7. Recent Accounting Pronouncements

     In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 has not had a material impact on the Company’s financial statements.

     In December 2002, the FASB issued SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123.” This Statement amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of SFAS 148 are effective for financial statements for fiscal years ending after December 15, 2002, and disclosure requirements are effective for interim periods beginning after December 15, 2002. The Company continues to account for stock-based compensation to its employees and directors using the intrinsic value method prescribed by APB Opinion No. 25, and related interpretations. The Company started making the disclosures required by SFAS 148 in the consolidated financial statements for the year ended December 31, 2002. Accordingly, adoption of SFAS 148 does not impact the Company’s financial position or results of operations.

     In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS 150 changes the accounting for certain financial instruments that under previous guidance issuers could account for as equity. It requires that those instruments be classified as liabilities in balance sheets. The guidance in SFAS 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective on July 1, 2003. The Company does not anticipate that the adoption of SFAS 150 will have a material impact on its financial position, cash flows or results of operations.

8. Acquisition of Certain Rights to the Chariot Products

     On July 7, 2003, the Company acquired from NetIQ Corporation (i) a perpetual license to the source code for NetIQ’s Chariot products for the development, manufacture, marketing and distribution of derivative products (ii) certain additional intellectual property rights associated with the Chariot products and (iii) exclusive U.S. and Canadian distribution rights for NetIQ’s existing Chariot products through December 31, 2004. The Chariot products allow users to simulate full-scale enterprise networks with a mixture of traffic types, including VoIP, Multicast, Oracle and SAP business transactions.

     These rights were acquired for a total price of $18.1 million, plus royalties on sales of NetIQ’s existing Chariot products through December 31, 2004. The $18.1 million consisted of a $17.5 million payment to NetIQ and acquisition-related expenses. The Company will pay a minimum royalty of $500,000 each quarter, subject to certain credits in the event of payment of the minimum royalty. Between September 1, 2004 and January 15, 2005, the Company may exercise an option to purchase the remaining assets of NetIQ’s Chariot business for a cash payment of $2.5 million. The following table summarizes the estimated fair values of the assets acquired at the date of acquisition (in thousands):

     The acquired other intangible assets consisted of $591,000 for trademark rights, $395,000 for workforce and $591,000 for customer relationships. The purchased technology is being amortized using the greater of (a) the ratio of current revenues to the total of current and anticipated future revenues or (b) the straight-line method over the remaining estimated economic life of seven years. Other intangible assets are being amortized using a straight-line method over their expected useful lives of between 4 and 7 years.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. The results of operations for the three and nine months ended September 30, 2003, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2003, or for any other future period. The following discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report and in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, including the “Risk Factors” section and the consolidated financial statements and notes included therein.

OVERVIEW

     We develop, market and sell high performance IP network testing solutions. Our products allow customers to generate network and Internet protocol traffic and analyze the performance, accuracy and reliability of equipment and systems that they either manufacture for sale to others or purchase for use in their own networks. Our solutions utilize a wide range of industry-standard interfaces, including Ethernet, SONET, BERT and ATM. Our customers include manufacturers of network equipment, Internet and network service providers, semiconductor manufacturers and network users.

     Our product offerings include a variety of interface cards, chassis that hold the interface cards and related software products. Our interface cards utilize a variety of interfaces — Packet Over SONET, BERT, Ethernet and USB. The following table sets forth, for the periods indicated, our net revenues by principal product category in dollars and as a percentage of total net revenues:

     Sales to our five largest customers collectively accounted for approximately $9.2 million or 42.7% of our net revenues for the three months ended September 30, 2003 and $8.4 million or 49.9% of our net revenues for the three months ended September 30, 2002. Sales to our five largest customers collectively accounted for approximately $26.1 million or 43.2% of our net revenues for the nine months ended September 30, 2003 and $25.0 million or 50.4% of our net revenues for the nine months ended September 30, 2002. To date, we have sold our products primarily to network equipment manufacturers. While we expect that we will continue to have some customer concentration for the foreseeable future, we continue to sell our products to a wide variety of customers and to the extent we develop a broader and more diverse customer base, we anticipate that our reliance on any one customer will diminish.

     Net Revenues. Our revenues consist primarily of hardware and software product sales. In some instances our software products are installed on and used in conjunction with our hardware products. At other times our software products are installed and run on other companies’ hardware. Our software does not require significant modification or customization, and our sales do not involve any significant future obligations or customer acceptance terms. Accordingly, product revenue from product sales is recognized upon shipment. We warrant the hardware and software components of our products for up to one year after sale. At the time of sale we defer the portion of our revenues that relates to our post-contract support and recognize it ratably over the service period. Revenues from maintenance contracts are deferred and recognized ratably over the term of the contracts.

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     Cost of Revenues. Our cost of revenues consists of materials, payments to third party manufacturers, salaries and related expenses for manufacturing personnel, royalty payments and the warranty cost of hardware to be replaced during the warranty period. We outsource the majority of our manufacturing operations, and we conduct final assembly, supply chain management, quality assurance, documentation control and shipping at our facility. Accordingly, a significant portion of our cost of revenues consists of payments to our contract manufacturers. In addition, cost of revenues includes a non-cash component related to the amortization of purchased technology and amortization of deferred stock-based compensation related to manufacturing personnel.

     Gross Profit. Excluding the effects of stock-based compensation, the gross margins of our various interface cards and software have generally been consistent and have exceeded the gross margins of our chassis. In general, our gross margins are primarily affected by the following factors:

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the pricing we are able to obtain from our component suppliers and contract manufacturers;

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the mix of our products sold;

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new product introductions by us and by our competitors;

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production volume;

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changes in our pricing policies and those of our competitors;

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demand for our products; and

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the mix of sales channels through which our products are sold.

     Operating Expenses. We generally recognize our operating expenses as incurred in four general operational categories: research and development, sales and marketing, general and administrative and amortization of other intangible assets. Our operating expenses also include a non-cash component related to the amortization of deferred stock-based compensation related to research and development, sales and marketing and general and administrative personnel.

     Research and development expenses consist primarily of salaries and related personnel and consulting costs related to the design, development, testing and enhancements of our systems. We expense our research and development costs as they are incurred. We also capitalize and depreciate over a two-year period some costs of our systems used for internal research and development purposes.

     Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in sales and marketing and customer support functions, as well as costs associated with promotional and other marketing activities.

     General and administrative expenses consist primarily of salaries and related expenses for executive, finance, human resources, information technology and administrative personnel, as well as recruiting and professional fees, insurance costs and other general corporate expenses, including rent.

     Amortization of other intangible assets consists of the expensing of intangible assets obtained primarily through our acquisition of businesses and technologies over the estimated useful lives of the assets.

     Deferred stock-based compensation represents the difference between the deemed fair value of our common stock for accounting purposes and (1) the exercise price of the options and warrants at the date of grant or (2) the purchase price of the restricted stock. At the date of grant, deferred stock-based compensation is presented as a reduction of shareholders’ equity, with amortization recorded over the vesting period, which is typically four years. Deferred stock-based compensation at September 30, 2003 decreased from deferred stock-based compensation at June 30, 2003 by $11,000 and from December 31, 2002 by $197,000 as a result of the forfeiture of unvested stock options. Deferred stock-based compensation at September 30, 2002 decreased from deferred stock-based compensation at June 30, 2002 by $98,000 and from December 31, 2001 by $467,000 as a result of the forfeiture of

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unvested stock options and changes in the market value of the Company’s common stock that affected certain equity instruments which receive variable accounting treatment. We amortized to the respective expense categories $397,000 of deferred stock-based compensation in the three months ended September 30, 2003 and $1.1 million in the three months ended September 30, 2002. We amortized to the respective expense categories $1.5 million of deferred stock-based compensation in the nine months ended September 30, 2003 and $4.3 million in the nine months ended September 30, 2002. Based on the unvested options as of September 30, 2003, we expect to record additional stock-based compensation expense relating to deferred stock-based compensation approximately as follows: $393,000 during the remaining three months of 2003 and $423,000 during 2004. The amount of deferred stock-based compensation expense to be recorded in future periods could decrease if options for which unearned compensation has been recorded are forfeited or repurchased.

RESULTS OF OPERATIONS

     The following table sets forth certain statement of operations data as a percentage of net revenues for the periods indicated: